Introduction
Building can be a very exciting but also intimidating exercise. Acquisition of finance has always been one of the major key first steps in any construction process, and it is here that construction loans shine. Construction loans differ from most other types of traditional mortgages, for they are meant specifically for funding the building of a home or commercial property. In this article, we go through more detail on construction loans, including different types, an application process, requirements, and benefits.
What is a Construction Loan?
This can be considered as a short term, high interest loan meant for funding of a construction activity. Whereas the normal mortgage pools together long term funds for a property already built, construction loans are disbursed incrementally, as the work of construction progresses. In other words, it is made available to pay for the costs for the actual construction, be it materials, labor or permits.
Types of Construction Loans
- Construction-to-Permanent Loans: This funding contains elements of construction finance as well as permanent finance. A construction loan funds the construction process; then, after completion, it transforms into a permanent mortgage. It saves the parties involved money because they close more than it usually would and simplifies the entire process for funding.
- Stand-alone Construction Loans: Short-term loans whose sole purpose is to finance the building process. They will not automatically roll over into a permanent mortgage upon completion of construction. Upon completion of the construction process, the buyer will need to take out a second mortgage in order to finance repaying the construction loan. This would then expose the buyer to extra closing costs and fees.
- Owner-builder Loans: These are for the homeowners who want to act as their own general contractor on their individual projects. It is often more difficult to qualify for owner-builder loans because owner projects involve a bit higher risks. The lender might require more documentation and sometimes requires a more extensive level of construction experience.
Construction Loan Application
A construction loan application is different from the run-of-the-mill mortgage application. This is what exactly happens in the step-by-step process while applying for construction loans:
- Paperwork on Finances: A lender wants very deep paperwork to explain one’s creditworthiness. Such paperwork may include personal tax returns, bank statements, proof of income, and a detailed budget for the construction project.
- Prepare a Proper Construction Plan: The lenders are eager to witness clear planning of the scope, time scale, and budget of your project. A complete construction plan should have architects’ drawings, permits, and other requirements.
- Choose an Experienced Builder: If you are not a general contractor, you will need to choose a builder or contractor who is qualified for the job. Usually, this is a requirement of the lender in terms of qualifications, including licensing and insurance.
- Apply Now: Carefully bring all the supporting documentation so that you may not miss a deadline about submitting your application. Collect all the information that is enough to answer for the timeline and cost of the project.
- Undergo the Appraisal: This will make the lender have to go through an appraisal where the value of the complete project that will be achieved at the end is revealed. It, therefore, gives them a basis on how much risk is involved in funding your construction.
- Obtain Commitment: Once approved, you get a letter committing you to the fact that all terms to be used while administering your loan will be added there, including interest rates, amounts, and how to repay.
Disbursements
Once a construction loan has been accepted, the lender pays out money advanced from that is comprised of sums calculated based on work completed in the construction process. Several draws are typically taken in phases, simply called “draws.” A draw is tied to previously defined phases, such as when the foundation is put in or when the framing is complete. This allows a lender to track how the project is being staged and ensure the funds advanced will be applied for their intended use—that is, the purpose they were made available for.
Benefits of Construction Loans
- Tailor-made Finance: These are loans tailor-made directly to meet the needs of the builders and developers. This can be a very large source of funding flexibility.
- Short-term Nature: The construction loan is usually short-term; it helps the borrower avoid long-term debt during their period of the project.
- Availability of Funds on Demand: The draw system will enable a borrower to access the funds only when needed; over-borrowing or creating unnecessary debt is thereby avoided.
- Lower Interest Rates: They normally tend to have savings on the aspects of lower interest compared to other financing, though mostly computed upon conversion to a permanent mortgage after completion.
Conclusion
A construction loan is very important to one who constructs his house or his commercial properties. Knowing the kinds of construction loans, how to apply for them, and their benefits can empower you on more issues of having good reasoning power in your life. One may opt for a construction-to-permanent loan or go for the stand-alone construction loan, but proper planning and preparation are all keys to success in constructing.
