When contemplating building or renovating your dream home you may want to consider a construction loan. A construction loan is a short-term loan that offers funds for the cost of building, renovating or reconstructing a home.

A Closer Look at Construction Loans

Construction loans often have higher variable rates than permanent mortgage loans, as only the interest payments are typically made during construction. The lender will request to be provided with a fully detailed plan of the construction timetable to give approval of the loan. The funds borrowed through this type of loan are generally provided throughout each phase of construction. Construction loans are often obtained by large scale construction companies, new home builders or individual homeowners. There are two types of construction loans:

One Time Close Construction Loan

You can pay the lender back in a lump sum. Additionally, you can convert your loan into a mortgage loan known as the construction-to-permanent loan and pay both loans one once the construction is complete.

Two Time Close Construction Loan

This is actually two loans wrapped into one where you have to pay the loan twice. Once during the construction phase, and then, another permanent mortgage loan once the construction is complete.

A mortgage loan may be a better option if you are purchasing a fully constructed house. If, however, you are getting a loan for a home that is under-construction, then you not only have to pay for the mortgage, but will be responsible to cover the costs of the construction material, labor expenses, etc. Typically, once the home is completely constructed, you have the time period of one year to pay back the loan. It will depend on who you are getting the loan from and your credit history. Be sure to check out all your options and compare the different types of loans you can qualify for before making a final decision.

Qualifying for a Construction Loan

Below are some tips to remember when qualifying for a construction loan:

• Credit score plays a very important role in securing a construction loan as lenders check your score to make sure they are investing in the right place. Having a good credit score can help you qualify for a construction loan. The higher your score is, the higher your chances of being approved.
• A low Debt-to-Income ratio (DTI) can help borrowers qualify for a home construction loan. Cut down on spending, and pay off your debts to increase your chances of qualifying.
• It is a good idea to plan for enough cash reserves to pay for at least 6 months of expenses in your new home. If lenders know you are financially secure, it is very likely they will invest in your project.
• You need to know exactly how much you will need for construction purposes before applying for a loan. Prepare a construction plan and secure a contractor to help get estimates of how much all the equipment and materials will cost. Knowing the estimated amount of money required for the construction project upfront will help the lenders determine whether to fulfill the loan.
• Lenders often require a down payment of 20 percent to apply for a construction loan. This down payment serves as a security deposit for the lender. It helps ensure them that the project they’re investing in is genuine and helps to prevent the borrower from walking away during construction.

The Construction Loan Process

Qualification is only the first step in obtaining a construction loan, the next step is completion of the application process. Find a trusted lender and prepare the specified documents required to apply for a home construction loan. 

Once you secure the loan, the lender will expect all of the funds to be used towards the materials and labor. These include construction of the house, utility hookups, water well, septic tank, pool design, etc. The loan is solely for the purpose of expenditures associated with the construction of your home.

Once construction is complete, you will then need to pay your second loan, i.e. the mortgage. As stated above, you can choose to convert your construction loan into a mortgage loan upon completion of the project. Not all lenders offer this choice, so you will need to clarify with them prior to obtaining the loan if this option is offered.

Summary

This article provides basic information about construction loans. It helps you understand what a construction loan is, how to qualify for a loan, and the process of obtaining a construction loan. Knowing the basics of construction loans and everything that comes with a construction loan can help you decide if a construction loan is right for you.