Generally, when you look to purchase a new home, consider the mortgage options available to help cut costs. But what do you do when you want to build a custom home, or as I like to call it, your dream home? That is where construction loans come in, but how does it work? What else do you need to know about construction loans, and how can you get one?
A construction loan is a short-term loan that you can use to build a home or a real estate project. It covers the building of the structure, this includes; the land purchase, the contractor labor, materials to be used, permits needed, etc. There are different types of construction loans, and the one you choose will likely depend on the project type.
That said, there are also other considerations and factors you must be aware of before proceeding. Read on to learn more about how construction loans work, the types, and other important factors you should know about. So, let’s dive right into it without taking too much of your time.
What are construction loans, and how do they work?
As I have mentioned earlier, a construction loan, also termed a “self-build home,” is a short-term financing. This loan is used for building a new home and sorting out other construction expenses such as permits, labor, and building materials needed.
Potential homeowners usually take construction loans, usually for a short period. After the home has been built, the homeowner has two options: he/she can either pay off the loan in full or convert it to a mortgage.
What are the different types of construction loans?
Construction loans come in different styles to help homeowners meet their financial needs. Here are the different types of construction loans and how they work.
1. Construction to permanent loan
The Construction to permanent loan works in a very straightforward way. It is designed to cover all the construction costs until the building is completed. Afterward, the construction loan or cost is rolled into a traditional mortgage.
The lender will require you to pay the loan’s interest while the home is still in the building process. After the building is completed, you will have to pay the principal monthly, which is the monthly mortgage payment.
2. Construction only loan
The construction-only or the stand-alone loan is designed in a slightly different pattern and is fairly self-explanatory. It is designed not to convert the construction cost into a mortgage; you will have to pay the principal back in a lump sum upon home completion.
However, you will still be required to pay the interest during construction. This construction loan type avoids the complexities of rolling the construction loan into a mortgage. However, you will need a lot of finance at hand at the end of the project to pay off the loan principal.
Alternatively, you still have the option of taking a mortgage to pay off the principal for the loan. This means you must submit another application and pay two sets of closing costs. To many homeowners, this is a hassle and will incur even more expenses at the end. As a result, most homeowners who are low on savings or not too financially buoyant choose the Construction-to-permanent loan.
3. Renovation loan
A renovation loan is very similar to a construction-to-permanent loan. However, the renovation loan is meant for renovation, not building. It is meant for homeowners needing major home changes, e.g., a new bathroom or kitchen expansion. After the renovation, the cost is rolled into a mortgage, just like the Construction-to-permanent loan.
4. Owner-builder construction loan
Although it is not too common, it is still worth mentioning. The Owner-builder construction loan is designed for borrowers who want to build a house. However, due to the complexities of building a house, you must prove to the lender that you are experienced enough to build your own home.
5. End loan
Remember when I said if you take a Construction-only loan, you still have an option of taking a separate mortgage to pay off the principal? That separate mortgage you take to pay for the loan principal is the end loan.
What are the construction loan requirements?
The requirement for getting a construction loan varies from lender to lender. However, here are a few common requirements among a majority of lenders. The lending company will require the borrower to;
- Be financially stable with a low debt-to-income ratio and sufficient income to repay the construction loan
- Make a down payment, usually the interest of around 20%, to be paid before or during the building process
- Have a good credit score; most lenders require a minimum of 680
- Have a good construction plan stating all the key parameters of the project, including the expected time of completion
- Get a home appraisal since the home may serve as collateral and must be sufficient to secure the loan. They will need the appraisal to estimate how much the finished home will be worth
How to get a construction loan
Getting a construction loan is similar to a regular mortgage loan but with very few differences. Generally, you should follow the following steps;
1. Get your preapproval
Getting your preapproval is the first step to getting your construction loan. It gives you an idea of how much you can borrow for your project before diving into it. This will help you and the architect or contractor to be able to design a plan that will match the loan budget.
2. Get a licensed builder
You will need a builder or a contractor with expertise; you want to show the lenders how prepared you are for this project. Getting a licensed contractor like Samkins Construction LLC does not only guarantee that you are prepared for the project but also means you plan on getting the best.
3. Get all documents together
You must present various documents to the lending company before your loan is approved. The documents or paperwork you will be asked to present includes (but are not limited to) the following;
- The plan for the project, including the estimated time for start and end of project
- Licenses and statement of payment
- Appraisal for the project
- Home design and structural plans
- Homeowner’s insurance, etc
4. Close the loan
The construction loan process usually ends with your signature confirming you have accepted all the terms and conditions of the loan. Please review the stated terms and conditions for the loan before affixing your signature.
What does the construction loan cover?
The construction loans cover the land purchase, plans, permits, labor, and other contingencies related to building the structure.
Is building a custom home a good investment?
Building a custom home is always a good investment, especially if the home is located in a very good region; the home is bound to appraise higher over time.
Is it hard to get a loan?
Well, truth be told, getting a construction loan can be quite an hassle. However, if you have a good credit score and sufficient income to repay the loan, getting one for your project should be easy.
What does a construction loan cover?
Basically, the construction loan covers all expenditures related to the building of the structure.
Conclusion – How construction loans work
Construction loans can be very handy when deciding to build your dream home. But you must be aware of the terms and conditions that come with the loan. This is one of the reasons it is advised to seek the expertise of an experienced individual before you affix your signature on anything.
At Samkins Constructions Lnc, lenders are ready to work with us and our clients. We do not guarantee getting the loan for the project as we have no control over that. But we guarantee we get our clients the best possible terms, conditions, and interest rates. Get in touch now for any questions or clarity you may seek.
Thanks for reading.