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- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Home Construction Loans
Having a home constructed is a big and certainly a costly step. You can of course take a loan to fund this construction, however, it is a different kind of mortgage than the one you take when buying a home.
Let us take you through everything you need to know about home construction loans.
What are Construction Loans?
A construction loan provides funds required to build a residential property at a higher interest rate and shorter term.
These loans usually have a duration of 1 year and during this duration, the property must be built, and the certificate of occupancy must be issued.
You may use a construction loan to cover the costs of land, building material, contractor labor, permits, etc. it is very important that you discuss all of these things with the lender and specifically what is going to be included in the loan-to-value calculation.
Construction loans also include an emergency reserve which can be used to cover some unexpected costs that arise during the construction.
This also serves as a buffer or cushion in case you want to make any upgrades after the construction has begun.
How does a Construction Loan Work?
Construction loans usually come with variable interest rates that fluctuate depending upon the prime rate.
The loan rates of Construction loans are higher compared to traditional mortgage loans.
This is because, in the case of traditional loans, there is a collateral assigned that is your home, however in the case of construction loans, there is no collateral and thus it is a bigger risk for lenders.
You need to give the lender the details of construction like, detailed plans, construction timeline, and a reasonable budget because construction loans typically have short terms and depend on the completion of the construction project.
Once the application is approved, the borrower is placed on a draw schedule that follows the construction project stages and is usually only expected to make interest payments during construction.
In a construction loan, the lender pays the funds in stages as the construction work of the new home progresses, unlike a personal loan where the loan amount is given as a lump sum.
During construction, the lender gets an inspector or appraiser to check the house at different stages.
The lender then makes additional payments to the contractor if the appraiser approves.
You may be able to convert your construction loan into a traditional mortgage loan once the construction is complete depending on the type of loan.
Construction Loan Types
Construction-to-permanent loans
These loans provide you with funds to build the house and for your permanent mortgage as well.
In simpler terms, in a construction-to-permanent loan, you borrow money and pay for the construction of the home, and once you move in, this loan is converted into a permanent mortgage.
The advantage of this type of construction loan is that you only have to pay one set of closing costs and thus it reduces your overall fees.
Construction only loans
This type of loan provides funds required to cover the construction of the house and when it is complete the borrower has to either pay the loan back in full or get another mortgage to secure financing.
A construction-only loan disburses funds based on the progress of the construction and you are only responsible for the payment of interest on the funds drawn.
A construction-only loan is costlier as you will most probably need to get another mortgage to pay it off and thus you end up paying two different sets of fees and costs.
Renovation loans
You can go for a renovation loan if you are looking to make upgrades to your existing home. This loan has a variety of different forms depending on the amount of money you need for the construction.
You could just get a personal loan or pay using your credit card if your plan is to spend less than $20,000 on the renovation. If you need $25,000 or more, you can use a home equity loan or a line of credit if you have equity built in your home.
Due to the low-interest rates, HELOC is often the most affordable mortgage to borrow large sums of money. Another good option could be a cash-out refinance.
Owner-builder Construction Loans
An owner-builder loan is basically a construction-only loan where the borrower also acts as the home builder.
Most lenders do not approve of this as it takes the experience needed for constructing a home and the complexity of the process.
Some lenders may approve only if the borrower is actually a licensed builder.
End Loans
This refers simply to the borrower’s or homeowner’s mortgage once the house is built.
This is the loan or mortgage that the borrower will need to pay off the construction loan once the construction is complete.
Factors to Consider
Have a word with your contractor before choosing a construction loan and discuss with him the timeline of the construction and if any other factors could affect the job.
Make a decision on whether you want to go through two different loan processes or just one.
When considering a construction loan, you not only need to account for the construction of the house but also the purchase of the land and you also have to figure out how you will manage to pay the loan back after the construction is complete.
Conclusion
A construction loan as the name suggests is used to fund the construction of a new home or renovations made to an old one.
These loans typically have higher interest rates as there is no collateral assigned which makes it riskier for the lenders.
Construction loans also have a much shorter duration, usually around 1 year. Depending on what you need you can choose from different types of construction loans.
