Are you looking forward to constructing your dream house? If yes, then construction loans will help you make this dream a reality. Unlike standard mortgages, these loans are particular to the construction phase of a home project. Such loans cover everything from purchasing land to completing the final build. 

Want to know more about construction financing and how they work? Luckily, you have landed at the right place. In this blog, we will help you understand the intricacies of construction loans, covering the types of loans available and how the process works.

Let’s first begin by understanding what exactly construction loans are. 

What are Construction Loans?

A construction loan is a short-term loan taken to cover the costs of building a new home. It is used to provide funding for

• Purchasing land

• Funding contractor fees

• Acquiring building materials

• Paying for necessary permits. 

However, not all design costs will be covered. For example, paying architects or interior designers is typically paid out of pocket.

Furthermore, there are several types of construction loans for building a house. Let’s explore them. 

Types of Construction Loans

Each type of construction loan is distinct and fulfills a particular purpose and budget. Here is the detailed information of them.

Construction to Permanent Loan

A construction to permanent loan starts as a construction loan, and when the building is complete, it is transitioned to a traditional mortgage. This loan does not require multiple closings and, therefore, has fewer closing costs. Also, during the construction phase, you are required to pay only interest. At the completion of construction, homeowners can select between a fixed or variable interest rate.

Construction Only Loan

Unlike a construction-to-permanent loan, this loan only caters for the construction period. When the project reaches completion, the loan is fully paid off. Most homeowners are obliged to cover the remaining balance using a traditional mortgage after the completion of construction.

Owner Builder Loan

An owner-builder loan gives you the ability to act as your own builder. However, this type of loan is predominantly given to licensed builders due to the complexities involved in a construction project.

Renovation Loans

If you’re seeking to repair a certain property as opposed to building a new one, renovation loans grant you funds for enhancement and construction. If you wish to tailor an older building, renovation loans become an ideal option to pursue.

What exactly is a construction loan, and how does it work?

Your property can be turned into a customized dream home with the help of construction loans. The funds are allocated in stages more commonly known as ‘draws.’ These draws are released as the construction is completed in aspects such as laying the foundation of the property or installing the frames. Rental payments on the construction loans are initiated during the construction phase, and the principal payment, combined with interest, is paid at the end of the loan period. Loans such as these have a year repayment period and also come with a term of interest-free property rental.

Construction loans entail constant evaluation, unlike typical mortgages that provide all the funds in one go. In order to ensure the work is being conducted, the contractor must be in communication with the lender for progress updates during the entire process.

Moving further, you must be wondering what the difference is between traditional mortgages and construction loans. That is exactly what we are about to discuss now. 

Traditional Mortgages versus Construction Loans

A construction loan is different from a regular mortgage because:

• Unlike a mortgage loan, funds for construction are distributed in phases according to progress made.

• Repayment Structure: In the case of mortgages, payments for principal and interest begin as soon as the mortgage is drawn. Construction loans, on the other hand, usually require payments only for interest during the period of construction.

• Inspection and Appraisals: Lenders monitor the progress of the building regularly by conducting inspections, ensuring funds are disbursed only when important milestones are achieved.

Now, we will look at the requirements of getting a loan for construction financing and its rates. 

Construction Loan Rates and Requirements

In the world of construction, loans to build a house tend to be slightly harder to get, given the risk that is involved alongside the building of a home in nonexistent land. This leads lenders to believe construction loans pose a great potential for risk. Because of this, construction loans almost always sit at higher interest rates than traditional home loans. Market fluctuations further lead to them being subject to massive change. Similarly to other loans, borrowers will need a strong credit score below 680 and an outline of their income for proof purposes. While many construction loans require a 20% down payment, some do dissuade from that.

Steps to Secure a Construction Loan

Because construction loans are more inclined to have additional steps than most normal mortgages, protection tools need to be set in place to help secure approval:

1. Find a licensed builder: Tell your lender your goal and about your builder's

2. Pick a construction loan lender: This requires research and helps you gain insight into what is needed with your project.

3. Put together and submit all documentation: Lastly, prepare for a lot of paperwork. A good builder will make the process easy, as well as provide you with the planning outline and financial details.

4. Get Preapproved. Preapproval lets you know how much you can borrow, allowing you to better plan your project.

5. Secure Homeowners Insurance: Even during the construction phase, lenders will generally be asking for builder's risk insurance so that there are no potential losses while building.

Conclusion

Constructing your house is not only an exhilarating process but also a very painstaking one. Acquiring a construction loan is also one of the vital steps needed to make your dream come true. No matter if you are using a construction-to-permanent loan, a renovation-type loan, or anything else, these options are always available for your project.

If you are ready, consider getting a construction loan with Capital Key Lending. We offer straightforward loan programs along with extravagant customer service and competitive rates. We will gladly assist you in the stress-free process of private real estate lending. Let us help you build the home of your dreams!