Thinking about Getting a Construction Loan? Read this First!

If you have been going from house to house and not finding anything you want, you might be considering abandoning your home search and instead considering a construction loan or building the home of your dreams.

While constructing a new home is costly, it is not impossible, especially if you take out a loan specifically for this purpose.

What is a Construction Loan and How Do They Work?

A construction loan is a short-term loan (typically around a year) used to back the construction of your home from start to finish. When your home is complete, your construction loan changes to a permanent mortgage with a construction-to-permanent loan. You will only pay interest on your loan during construction, and your payments may be tax-deductible.

You will save time and money with only one set of closing costs. Please, check your local mortgage specialist for construction loan rates.

Before getting a construction loan, plan it out. To get a construction loan, you’ll need to provide the lender with precise plans for the project, including cost estimates, in addition to establishing your creditworthiness and ability to repay the loan. The contractors building your home may also need approval from the lender.

You get approval for a construction loan until you figure out all of these details. However, you might want to start talking to possible lenders so you will have a better idea of how much money you can borrow.

Your builder will get the first disbursement of funds once you have your plan in place, loan approval, and are ready to break ground.

You won’t get the money for a construction loan all at once or in a lump sum. Rather, the contractor gets a series of payments known as “draw.” When your builder asks for a new draw (for the next stage of work), the inspector will visit the job site and inspect the progress.

Make sure you and your builder fully understands the lender’s draw schedule, including when and how disbursements are made, before breaking ground.

You can usually make interest-only payments on the loan throughout construction. What’s even better is that you’ll only be charged interest on the amount that has been disbursed.

Types Of Construction Loans

You’ll need to decide which form of loan makes the most sense for you when you browse around for loans. There are several types of construction loans available, each with its own set of benefits, drawbacks, and regulations. Let’s take a closer look.

Construction-To-Permanent Loan

A construction-to-permanent loan is a loan used to build a house and then it converts to a permanent mortgage after completion of the construction.

All of your financing is integrated into a single transaction with this form of loan, so you’ll only have to fill out one application and go through one closing process. This can make it easier to finance your home.

You also won’t have to worry about being unable to secure mortgage financing once your property is finished if you use a construction-to-permanent loan. There’s no need to go through the approval procedure again once you’ve received your loan approval; the loan will simply convert to a permanent loan once construction is completed.

Construction-Only Loan

A construction-only loan does exactly what it says: it provides financing solely for construction. After that, you’ll need to refinance the construction loan into a mortgage using a separate loan.

Homeowners who want to renovate their current house can refinance into renovation mortgages, which will provide them with the finances to do so. Funds from a construction loan can only be used to construct your home. You can’t spend any of your remaining funds to furnish your new home.