How Does the Construction Loan Process Work?

Many people dream about one day constructing their own home. It may be time to start thinking about a construction loan if you want someday to come soon. On the other hand, construction loans are distinct from traditional mortgage loans, and it's critical to grasp the differences. Here's a brief overview.

Funding

If you're thinking about buying a house for the first time, you could be considering a mortgage loan. A mortgage is a loan secured by an existing structure. However, if you want to build your ideal home, you'll need to qualify for a construction loan. Land, permits and fees, designs, labor and supplies, and closing costs are typically covered by construction loans. Construction loans are not available from all construction lenders, so you'll have to look for one that does.

The majority of construction loans are for a specified sum. During the construction process, specific amounts of the funds are delivered to the builder upon completion of particular elements of the house.  Borrowers usually are only responsible for interest payments on the construction loan during the construction phase. When the house is finished, most construction loans are converted to mortgages. Your mortgage payment will include principal, interest, and property taxes once construction is completed and you convert to a mortgage.

For numerous reasons, construction loans are more complicated than mortgage loans

Lenders consider them to be slightly riskier. As a result, construction loans have higher interest rates and shorter periods than other loans. Why? The lender has the house as collateral if you default on your mortgage payments. However, if you default on a construction loan, the lender is left with a partially completed house.

Construction loans involve a more significant number of persons. A mortgage loan is a contract between you and your lender. You'll have a third party involved with a construction loan: your contractor. Both your ability to pay and the contractor's ability to finish the task on schedule and successfully will be scrutinized by the construction lenders,

Building loans are frequently subject to deadlines. Many of them demand that construction be completed within 12 or 18 months and that a certificate of occupancy be obtained once it is completed.

Process of Approval

Because there is more for the lender to consider than for a mortgage loan, the approval procedure for a construction loan might be lengthy.

Just as with a mortgage, you'll have to show evidence of income (your salary), bank statements, work history, planned down payment, and your credit score and credit history to lenders. Because new construction is prone to delays and cost overruns, you may also need to show confirmation of additional cash reserves. Prepare to offer your house's plans, specifications, and drawings as well. All aspects of the house, including the outside grounds, are eligible for a construction loan.

Your contractor or builder will have to submit a budget based on the designs, specs, and drawings. Financial information from the builder, such as profit and loss or cash flow accounts, length of time in company, licensure, and other documentation, may be required by lenders.

Construction lenders will look over your application to see if you can show that you can pay both the construction loan and the mortgage. They'll look over the blueprints and the contractor's details to ensure that the house's budget is fair and that the contractor has experience building houses.

Getting pre-approved for construction financing before getting too far along in the planning process is a good idea. You don't want to spend money on plans, specifications, and drawings if you're not going to get the financing.

Making a Choice: Things to Keep in Mind

When you apply for a construction loan, think about the same things you think about when you make other housing decisions:

• Is it possible for me to get a construction loan and a home loan at once? Interest rates are at a level that hasn't been seen in a long time. It's essential to work with a lender to figure out how much you can afford to pay for both your construction loan and your home's mortgage now and in the years to come.

• Is my income or job stable? If you lose your job or your income goes down, you may not be able to get a mortgage (after the construction is complete). You want to make sure you can pay your mortgage over the 15 to 30 years it lasts.

• Is there enough money in my bank account to cover any delays or extra costs? Often, it takes longer and costs more to build a house than the initial estimates say. It's wise to think about the possibility.