Understanding Construction Loans – SmartAsset

Are you planning to build your own house or hire someone to build it for you? You may be wondering if a construction loan is right for your needs. Construction loans can be difficult to get, but they are a way to secure financing so you can build your dream home.

Basic knowledge of construction loans

When you mortgage a regular mortgage, the house you are buying acts as security for the loan. If you can’t pay back the loan, the bank can take the house to compensate. But with a construction loan, there’s no guarantee that the home will be foreclosed upon by the bank if you default. That’s why banks are often more reluctant to issue construction loans than mortgages. Here are some specifics on how construction loans work.

Get a construction loan

If you want a construction loan, a solid credit score may not be enough. It helps if you have a history of on-time repayment from a previous mortgage, a personal loan, or a small business loan.

You’ll also need to show the bank something that can instill confidence in your ability to build your home in time. That means building a plan, a budget, and a timeline.

If you are successful in securing a construction loan, you can expect it to carry a higher interest rate than a conventional mortgage due to the increased risk for the lender.

Your construction loan will also have a fixed term, and we’re not talking about the 30-year term most home loans take. Typically, you will have a loan term of 12 months, during which time the bank assumes that you will complete the construction of your home.

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The bank may also set benchmarks and periodically check your progress. That’s because you can’t get a one-time home loan. Instead, you get a new part of the stage for each step of the build.

Construction Loan / Perm

Some lenders, such as regional banks, offer permanent construction mortgages. These loans start out like a regular construction loan, disbursed in stages as you complete the construction of your home. You only pay interest on the money you have so far, not on the total value of the loan.

Once your home is completed, your loan will then seamlessly convert to a regular mortgage. From that point on, you’ll pay a combination of interest and principal as your mortgage amortizes. The main advantage of these loans? They allow borrowers to pay only a set of closing costs and complete just one application and underwriting process.

However, that doesn’t mean there won’t be any new funds coming due by the time you convert your construction loan to a mortgage. Some of the costs you may owe at the time include escrow payments for property taxes and homeowners insurance, unpaid interest from the construction phase of your loan, and rights premiums. own.

Conclusion

Not many people choose a construction loan when they are thinking of moving from renting to owning a home. Most new construction is financed and conducted by larger real estate and construction companies. Some individual homebuyers choose to purchase kits or prefab homes that come with built-in financing. If you choose to pursue a construction loan, it’s important to be realistic about your timetable and budget when applying for funding.

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Image credits: © iStock.com / grandriver, © iStock.com / kali9, © iStock.com/stevecoleimages

Amelia Josephson Amelia Josephson is an avid writer on financial literacy topics. Her areas of expertise include retirement and home buying. Amelia’s work has appeared all over the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.

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