When it comes to getting financing for a home, most people understand basic mortgages because they’re so simple and almost everyone has one. However, construction loans can be a little confusing for someone who has never built a new home before. In the years I’ve been helping people get construction loans to build homes, I’ve learned a lot about how it works, and wanted to share some insight that might help de-mystify the process, and hopefully, encourage you to pursue getting a construction loan to have a new home built yourself. I hope you find this information helpful!
How Construction Loans Work: The Basics
I’ll start by separating construction loans from what I’d call “traditional” loans. A traditional home loan is a mortgage on an existing home, that generally lasts for 30-years at a fixed rate where the borrower makes principal and interest payments for the life of the loan. These mortgages can be obtained through a conventional http://www.fasterloansllc.com/ lender or through special programs like those run by the FHA (Federal Housing Administration) and the VA (Veterans Administration).
In contrast, a construction loan is underwritten to last for only the length of time it takes to construct the home (about 12 months on average), and you are essentially given a line of credit up to a specified limit, and you submit “draw requests” to your lender, and only pay interest as you go. For example, if you have a $400,000 construction loan, you won’t have to start paying anything on it until your builder submits a draw request (perhaps something like $25,000 to start) and then you’ll only pay the interest on the $25,000.
Construction Loans Are Like A Big Credit Card
The best way to think about a construction loan is to compare it to a giant credit card that only lasts until the home is built. At that point, you then get a mortgage for the house you’ve built, which will pay off the balance of your construction loan. There are no prepayment penalties with a construction loan so you can pay off the balance whenever you like, either when it comes due or before then (if you have the means). So in a way, a construction loan has a balloon payment at the end, but your mortgage will pay this loan off.
Interest rates are also calculated differently: with a traditional loan, the lender will sell your loan to investors in the bond market, but with a construction loan, we refer to them as portfolio loans (which means we keep them on our books). We have the freedom to negotiate the right interest rate based on several factors. It’s not like an auto loan where you walk into the bank and look at the rate sheet on the wall that shows today’s interest rate (which could change tomorrow). I have the ability to look at “the big picture” and determine a rate based on many factors, including your credit, financial history, income and project equity.
You Need Both A Construction Loan And A Mortgage
Eventually, after our construction loan has funded your home’s construction, you will need to get a mortgage for the home which will pay off the construction loan. Something people ask me all the time is “do I have to get a mortgage from the same company that provided my construction?” and I’m happy to answer “No.” You have complete freedom in choosing your mortgage company. I finance people for construction loans all the time where I then hand them over another company to do the permanent mortgage.