A construction loan is the type of loan that one gets to finance the construction of a new building or buildings. There are two basic kinds of construction loans: home construction and commercial construction. New home construction loans are typically acquired by the homeowner to cover the cost of the builder and building materials. Commercial construction loans are acquired to cover the cost of building commercial or industrial structures.
Typically, the borrower needs to provide specific details about the building that is undergoing construction in order to acquire financing for the venture. The lender needs to ascertain the likelihood that the borrower will be able to repay the loan. If the borrower owns the land that the new home is being constructed on, that fact increases his chances of receiving the loan.
Two basic terms are offered for construction loans: short term or long term. Long-term construction loans offer more flexibility than in the past and provide such terms as 15 or 30-year fixed, interest only loans, and a variety of adjustable rate mortgages.
The short-term loan is in place only as long as it takes to complete the construction and acquire a certificate of occupancy. The lender provides money in intervals to the builder so that the work can continue to progress. The typical time frame for the short-term or construction part of the loan is 6 or 12 months.
Construction loans are often set up so that the lender collects only the interest portion of the loan while the home is under construction- the interest only loan. At the time the construction is completed, the loan either becomes due in full to the lender, continues as an interest only loan before being converted to a traditional loan, or it is converted to a fixed or adjustable rate mortgage loan.
If the loan is converted to a mortgage loan, this is known as a construction-to-permanent loan or financing program. The advantage to setting your construction loan up to convert is that you only need to complete one application and you only attend one closing. The disadvantage is that the interest rates on traditional loans can change during the time it takes to construct the home. Construction-to-permanent loans are also known as one-time close loans since you only attend one closing and save on closing costs.
Some construction-to-permanent loans allow you to lock in an interest rate through the construction and up until its completion. However, it is important to have an understanding of current interest rate trends at the time you apply so that you have a clear understanding of the advisability of locking in your interest rate. Plus, due to the possibility of construction delays, you should include an allowance for this in your agreement.
This kind of a mortgage can best be described as all inclusive loan, in that all expenses associated with the construction, lot purchase, closing costs and interest expenses are all added up to yield the total cost and then all ratios are calculated based on the total cost and the future value of the completed project.
The main components of a Construction loans are:
1- Soft costs of construction; consisting of architectural plans, engineering expenses and local authority permit fees.
2 Hard costs; which are all the actual physical costs of construction, including hook ups to utilities and landscaping.
3- Closing costs; consisting of origination and lender fees, title, and closing fees.
4- Inspection fees.
5- Reserves; consisting of interest reserve, which will make the payments during construction and contingency reserve which will be used in case of cost overruns.
6- Existing lot pay off. A construction loan is a first trust deed and as such all existing liens will have to be paid.
Regular purchase money or refinance mortgages are based on Loan to Value Ratio (LTV). Where as, Construction loans are based on LTV as well as Loan to Cost Ratio.
A very important factor to consider when applying for a construction loan with the intent of financing the purchase of the lot and the construction is the time line.
In order to do the appraisal of the subject property a construction lender will need a set of architectural plans, and in order to close the loan the plans must be submitted to the city or county.
One factor that makes the whole thing more complex is the fact that the way these numbers are calculated or the way the numbers are put together differ from one investor to the next.
In fact the calculations get complex enough that most loan officers in most lending institutions don't even know how to calculate a loan amount, unless if they are experienced construction loan specialists. This normally results in last minute unpleasant surprises.
The problem most applicants of new home onstruction loans face is when at the 11th hour they get a call informing them of the final loan amount as calculated by an underwriter which may or may not be sufficient to meet the borrower's needs, as in most cases insufficient loan amount means additional down payment requirements.
In short choose your construction lender wisley and avoid problems down the road.
Both Darin Ghaffari & Raz Vartanian are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Darin Ghaffari has sinced written about articles on various topics from Joint Venture, Finances and Debts Loans. Darin Ghaffari is a commercial finance expert and founder of , a worldwide financial powerhouse, offers the. Darin Ghaffari's top article generates over 1900 views. to your Favourites.
Raz Vartanian has sinced written about articles on various topics from Finances, Home Improvement How to. Raz is a career mortgage broker specializing in the origination and closing of Article Source: The FREE. Raz Vartanian's top article generates over 2900 views. to your Favourites.