A Complete Step by Step Guide into Construction Loans
Real estate remains one of the most profitable businesses that you can venture into. This is because as the population continues to grow, the demand for residential and commercial housing units is surpassing the supply, which pushes up the cost. Other benefits which come from real estate investment include tax exemptions, cash flow and a good cushion against inflation. While people know about the countless benefits of real estate investing and would do anything to make it part of their investment portfolio, not many have the economic muscle to pull off huge constructions. If you have a good construction idea but lack the funding you need to make it a reality, you should think about getting a construction loan. Here is what you need to know about construction loans.
Types of construction loans available
There are two major types of loans that are available for construction financing.
Construction to permanent
These are the types of loans where you borrow to cover the costs of the construction. However, when the construction is completed and you move in, the loan is converted into a permanent mortgage. The benefit of the loan is that you get a single closing, which reduces the fees you have to pay to access the service. During the construction process, you only pay an interest rate on the outstanding loan balance. When the contractor finishes building the home, your lender converts the loan into a mortgage. When the construction starts, the lender will lock down a maximum mortgage rate and require that you pay a down payment of at least 20 percent of the loan amount expected. The mortgage term ranges between 15 and 30 years.
This one is presented like two different loans. First, you get a loan whose purpose is to pay off all the costs related with the construction process. Then, when you move in, the lender will help you get a mortgage to pay off the construction loan debt. The loan is challenging to deal with because you have to pay fees for the construction loan and then for the mortgage. Unlike the construction to permanent loan, the standalone construction loan does not allow you to lock a permanent mortgage rate, which means that if interest rates rise at any point during the process of construction, you may have to pay more. Also, if you run into financial problems during the construction, you may have a very hard time qualifying for a mortgage.
The requirements you have to meet to qualify for a construction loan
When you are applying for a construction loan, the unbuilt home acts as collateral. This makes it a little difficult for the lenders to decide whether you meet the set borrowing criteria or not. However, they rely on information given by the contractors and subcontractors to make their judgment. This means that:
- You need to have a contractor who understands the construction process and can present your project in a manner which will get you the financing you need.
- You need to prove to the lender that you can meet the cost of monthly loan repayments during the entire period of the construction. In case the lender gets an impression that you are unable to meet your mortgage costs while your home is being built, they may not lend money to you.
- You also need to have money saved for unexpected costs that may arise during the process of construction. Most of the times, people get into cost overrun situations when they start changing their mind about what they want as the building process continues.
- You have to bear with regular inspections by the lender. Note that before a lender makes a draw or a payment, they have to send someone to inspect the progress and make sure that actual construction is happening.
- You have to choose your contractor wisely because one of the first things that your lender will look into is the credit profile of the builder and see whether they have financial or other shortcomings.
Therefore, the most important part of the process of getting a construction loan is the preparation. Fortunately, many companies have a very friendly and helpful approach to the people they lend construction loans to.
In conclusion, there are three huge benefits that you draw from getting a construction loan. First is the fact that you are able to access fast and easy construction capital when you need it. This means that you get the money, complete the construction and then pay off the loan. The second benefit is that with the permanent loan arrangement, you get more time to pay the loan back. Lastly, a lot of scrutiny will be laid on the construction plans, which means that your contractor will have to be honest and straightforward. As a result, your construction will be superior quality.