Construction loans are a type of financing that gives more new home buyers the opportunity to build the new construction home of their dreams. This article explains the basics of what a construction loan is and what’s involved in the process.
What is a Construction Loan and How Does It Work?
Quite simply, a construction loan is a short-term loan that finances the construction of your new home. The funds are released incrementally as certain construction phases are completed and are customarily paid directly to the builder. Typically, the monthly payments for a construction loan are based on an interest only payment plan. Upon completion of the construction period the entire loan balance is due. At that point, the construction loan may automatically convert to a traditional mortgage with the same lender (see “Construction-to-Permanent Loans” below), or the borrower must find another lender to refinance the construction loan into a traditional mortgage. Qualifying for a construction loan is like qualifying for a traditional mortgage (i.e., requirements regarding down payment, income, credit score, documentation, etc.), with the additional requirement that a licensed builder be involved.
Most construction loans fall into the “construction-to-permanent” category. Meaning that the short-term construction loan automatically converts into a traditional mortgage (e.g., fixed rate 30 year loan) once construction is complete. The construction loan is converted into a standard loan by the same lender who provided the construction loan once the construction of the home is completed. This saves time and money since the borrower only has to work with one lender, fill out one mortgage application, close once and can avoid duplicate fees.
Lenders typically allow you to lock in your mortgage rate for up to 12 months during construction. This is advantageous because you avoid the risk of interest rates going up while your new home is being built. And if interest rates go down during the construction period, borrowers can refinance at the lower rate.
Throughout the course of the construction portion of the loan (which can range from 6 – 12 months depending on the lender), the builder will receive draws based upon the percentage and/or stages of construction of the project which are complete. Prior to the start of your home build, the builder will submit a tentative draw schedule to your lender. The lender will confirm the schedule and then set up payments directly with the builder.
How to Find a Construction Loan Lender?
It is important to remember that not every lender offers construction loans. Since they involve the lender working directly with builders and paying out to potentially multiple vendors, the work involved is more than with a typical loan. You will want to find a lender that specializes in construction loans and ask about their experience in this particular area before you commit.
The home financing process can be confusing. That is why Evergreen Homes has assembled a group of highly rated Preferred Lenders with significant experience and success in home financing, including construction loans, as a resource for new home buyers. We encourage you to reach out to them if you have any questions regarding financing new construction homes in Canton, MI.