A construction loan pays for renovation or home building. However, the appraisal, approval, and disbursement processes vary from those of traditional mortgages.
Construction Loan Definition
A construction loan is a shorter-term mortgage with a higher interest rate that covers the cost of rehabilitating or building a house. A construction loan lender pays the loan to a contractor rather than the borrower. This loan is released in installments based on the progress of the construction project. The loan can be paid fully or converted into a permanent mortgage upon the completion of the building.
What Is Covered By a Construction Loan?
Construction projects are different. That’s why you should talk to your lender about the terms of your loan.
However, a construction loan will pay for the following:
- Land or lot for building a house
- Permits, plans, and fees
- Materials and labor
- Closing costs
- Interest reserves
- Contingency reserves
How a Construction Loan Works
A construction loan may not require collateral. That’s why some lenders are nervous about this loan. Thus, most lenders put borrowers through several looks before approving the loan. In most cases, the lender will inspect the architectural plans, the builder, and the finances of the borrower.
As hinted, a construction loan disbursement is done in installments. And, it is paid to the builder in draws. The draws coincide with the phases of the construction project. These phases can include foundation pouring, framing, and finishing work. What’s more, every draw requires an inspection and the amount to be disbursed depends on the completed work.
Some lenders also give home remodel loans. These are ideal for borrowers that want to upgrade their houses. The costs of repairing a house can also be included in the permanent mortgage. The amount that a home remodel loan can provide depends on the estimated value given by an appraiser after the upgrades or repairs.
Requirements for Construction Financing
In most cases, lenders consider the following before approving a construction loan:
- Debt-to-income ratio
- Credit score
- Repayment plan
- Down payment
It’s also crucial to choose your loan lender wisely. Look for a lender that understands your needs and is ready to give you the best interest rate and terms.