Construction

A construction loan is short-term financing that can be used to cover the costs associated with building a house, from start to finish. Construction loans may cover the costs of buying land, drafting plans, taking out permits and paying for labor and materials. You also can use a construction loan to access contingency reserves—if your project is more expensive than you planned—or interest reserves, for those who don’t want to make interest payments during construction.

Construction-To-Permanent Loan

Construction-to-permanent loans are a financing option that prospective custom home builders can apply for. Like construction-only, construction-to-permanent financing are one-time loans that fund construction and then convert into a permanent mortgage. During the construction phase, borrowers make interest-only payments. This loan type is best for Homeowners who want to save on closing costs and lock in mortgage financing.

Can I use any excess funds?

Borrowers never actually touch the funds made available through construction loans because they’re paid directly to the builder.

The contractor only receives payment for the work performed, and the borrower only pays interest on what’s paid out. You do save money if construction costs come in below the original amount of the loan, but you’ll have to find some other source of funds for that flat screen.

Do construction loans cover the design phase?

No. Prospective custom home builders have to self-finance the design phase of the home building contract. In addition, before you can take out a construction loan, you’ll need to produce a builder’s contract, construction timetable, designs and a realistic budget. All this needs to be done even before beginning the loan application process.

What are the typical loan requirements?

○ Be financially stable. To get a construction loan, you’ll need a low debt-to-income ratio and a way to prove sufficient income to repay the loan.
○ Make a down payment. You need to make a down payment when you apply for the loan. The amount will depend on the lender and the amount you’re trying to borrow to pay for construction, but construction loans usually require at least 20 percent down.
○ Have a construction plan. If you have detailed plans and a project schedule, especially if it was put together by the construction company you’re going to work with, it can help lenders feel more confident that everything will go according to that plan.
○ Get a home appraisal. The finished home will serve as collateral for the loan, so lenders want to make sure the collateral will be sufficient to secure the loan.

What does a construction loan cover?

Some things a construction loan can be used to cover include:
○ The cost of the land
○ Contractor labor
○ Building materials
○ Permits

It’s important to discuss these items with your lender, specifically what will be included in your loan-to-value calculation.

Oftentimes, construction loans will include a contingency reserve to cover unexpected costs that could arise during construction, which also serves as a cushion in case the borrower decides to make any upgrades once the construction begins.

There’s a lot to consider when choosing a construction loan lender, and it’s easy to get overwhelmed. For that reason, it can be tempting to settle for the first lender you find. You shouldn’t make this decision in haste. Make sure you choose a lender that fits your unique needs by asking these questions:

○ What types of construction loans do you offer?

○ What interest rates are available? Are they fixed or variable?

○ Do you charge closing costs or other fees?

○ Can I use the equity I have in my land toward a down payment?

○ How do you pay construction draws—as a percentage of completion or based on a set schedule?

○ Can the builder request a first draw to pay for materials?

○ What happens if there is a delay in building the home or a sudden increase in construction costs?