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What is a Construction Loan?

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Finding the answer to the question “what is a construction loan?” can be a complex process unless you understand that construction loans vary, and are sometimes quite dissimilar from each other. Below I’ll answer many questions associated with construction loans.

What is a Construction Loan: Features

While construction loans vary there are certain features which are the same or only involve a few choices.

• Construction loans usually require no repayment of the loan amount during construction.
• Construction loans do expect you to make interest only payments on the amount of money borrowed during various phases of the construction. You will only pay interest on the money actually used by the contractor. Money waiting in the construction account to be used does not accrue interest until it is used.
• Any unused money is returned to the bank at the end of construction, and you never pay interest or payments on that money.
• Construction loans are active only during construction. After that you will need a mortgage loan. In that way the loan is a balloon note. It’s all due and paid off by the mortgage loan, after the home is built.
• Construction loans usually require specialized insurance on the building site in the event of fire theft or other destructive accident or disaster.
• The amount of a construction loan is usually 10 to 20 percent more than the estimated cost of construction, to compensate for any over runs or changes in plans which may cost more.

What is a Construction Loan: Converting a Construction Loan to a Mortgage Loan
All construction loans should have a plan to be converted into a regular mortgage loan once construction is complete. The plan to convert to a mortgage loan is one of the ways construction loans vary.

One option which is very preferable in the current economy sets up the mortgage loan at the same time as the construction loan. This locks in current low interest rates. This is advantageous because interest rates are at an all time low, and a year from now they could be higher. It is doubtful they would be substantially lower. Setting up the mortgage loan as soon as possible alleviates worries and makes clients and loan officers feel more secure. Having a plan set in place for payments, with all the details made in advance is advisable because it leaves nothing to chance, and establishes the requirements of the loan before construction begins.

Another option assumes the client will need a mortgage loan but doesn’t set the loan specifications or the interest rate till after construction. When interest rates are low, or rising, this is not a good option. When interest rates are unusually high this could be a good option, but it is a gamble.

Setting up the details of your construction loan is usually facilitated by your loan officer, your contractor or home builder, and is usually assisted by the real estate agent who sold you the lot. All of these people want you to get the loan, and will help you to fill out forms as accurately as possible. It is important to be honest and not stretch the truth when talking to your home builder or contractor, your real estate agent, or your loan officer about your finances.

What is a Construction Loan: Tip

Be extremely truthful on all your loan application forms. Lending institutions have ways of finding out your personal and financial information, and they frown on any avoidance of the truth in your forms. In addition sometimes being truthful can help you get a better loan. FHA loans for example are designed to help people who have less than perfect credit and low or no down payment. In addition if you do not qualify for a loan, it is better to know that and make changes to your finances before building a home, than to default on your mortgage.

In general construction loans are tailored to your needs, and your truthful answers to all the questions will help create the best loan for you. It is an individualized process which is designed to help you get a loan which suits your needs. The question “What is a construction loan?” could be answered by asking “What sort of construction loan do you need?

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