How Does a Construction Loan Work?

How Does a Construction Loan Work?

Building a new home is a dream that many people think it’s unachievable. However, it’s possible to build a home or a commercial property with a construction loan. Nevertheless, getting this loan is a complex process for some people. Here is what you need to know about a construction loan.

Definition of a Construction Loan

A construction loan can be defined as an interim, short-term loan that pays for the construction or building of a home or a house. The money loaned for the construction project is paid by the lender in stages as the work progresses.

The maximum term for this loan is typically one year. Rates vary and they can move up or down depending on the prime rate. Nevertheless, this loan has higher rates than permanent loan mortgages.

Qualifications for a Construction Loan

To qualify for this loan, the lender needs the following: 

  • A construction timetable
  • A realistic budget
  • Detailed plans

Upon approval, the borrower enters a bank draw or draft. This is a schedule that follows the construction stages of the project. The borrower is expected to pay for the interest during construction. What’s more, the lender sends someone to validate the progress of the project whenever the loaned money is requested.

Types of Construction Loans

There are two main types of construction loans.

These are: 

  1. Construction-to-Permanent Loan

With this loan, you borrow money for construction costs. Upon completion and moving in, the loan becomes a permanent mortgage. Since this is a two-in-one loan, the borrower pays a single closing costs set. This reduces the fees owed the lender by the borrower.

     2. Construction-Only Loan

A construction-only loan entails taking out two different loans. One loan is for property construction only with a term of one year or even less. On moving in, you take a mortgage for paying off the construction. A construction-only loan doesn’t need a large down payment. It’s ideal for a person that already has a home but wants to build another house. Nevertheless, this loan can be costly because it involves two transactions with separate fees.

Generally, a construction loan covers the cost of materials and work for a new construction project. This loan can be used to finance contractor labor, permits, roof, and home framing, and interior finishing. It can also cover other expenses for building a house.

For more details and possible funding check out this website which breaks it down even further.