A construction loan is a short-term loan that covers only the costs of building custom homes. This is different from a mortgage and is considered specialty financing. Once the house is built, the potential occupant must apply for a mortgage to pay for the finished home. There are some specific differences between mortgages and construction loans.
Construction loans are short-term, usually no longer than one year. These are usually interest-only payments based on the amount you have anticipated on your loan. Mortgages are long-term and the money is received in a lump sum. Payments usually consist of principal and interest.
A home construction loan is a short-term loan with higher interest rates that provides the funds needed to build a residential property. When you take out a mortgage, your lender makes a lump sum payment to the seller of the home. With a construction loan, your lender disburses the money in increments as the builder completes different phases of his new home. These “giveaways” usually take place after an inspector or appraiser checks the builder's progress.
After approval, the money goes to the builder and the next stage of the process begins. More specifically, rates are usually about one percentage point above standard mortgage rates. You can find construction loan rates between 5% and 6% today. This is because construction loans are not secured by a finished home and are therefore riskier than traditional mortgages.
Getting approved for a construction loan may seem similar to the process of getting a mortgage, but getting approved to start building a new home is a little more complicated. An exclusive construction loan provides the funds needed to complete the construction of the home, but the borrower is responsible for repaying the loan in full at maturity (usually one year or less) or obtaining a mortgage to ensure permanent funding. Before you can get the funding needed to start your construction project, you'll need to get a loan approved. Unless you get a home construction loan through a government agency, such as the FHA or VA, you'll usually need to meet conventional mortgage requirements, such as having a credit score of 620 or higher and a debt-to-income ratio of less than 45%.
Construction loans allow future homeowners to borrow money to buy materials and pay for the labor needed to build a home. The funds from these construction loans are disbursed based on the percentage of the project completed, and the borrower is only responsible for paying interest on the money extracted. Ultimately, construction-only loans can be more expensive if you need a permanent mortgage, since you complete two separate loan transactions and pay two sets of fees. For that reason, the application and approval processes for a construction loan are also more complex than those for a mortgage.
The loan allows the buyer to process only one round of applications and procedures, and has the advantage of easily switching to a mortgage after the construction of the house is finished. A construction loan is a short-term loan specifically designed to build a house or some other real estate project. Learn about any processes or documentation required to get money from your construction loan so your contractor can use it. Fortunately, construction loans provide the funds needed to purchase land and pay for the materials and labor needed to build a new home.
On average, you can expect interest rates on construction loans to be about 1 percentage point higher than traditional mortgage rates and generally fall between 5 and 10 percent. Because construction loans are generally intended to cover the construction process, they are usually issued for a period of 12 to 18 months. Those who have a large amount of cash available or who intend to repay the construction loan with the sale of their previous home. .
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