If you are interested in building a home or have researched the process of buying a lot and building a house, then you have probably run across the term, “construction loan.” This makes many buyers nervous since it isn’t as well known of a term as “mortgage” and many wonder just what costs wait behind that loan, and how difficult it might be to get.
We’re here to help! Check out our quick guide on construction loans and what you need to know if you want to build a house or new addition on your property.
Construction Loan Definition
A construction loan is a loan that covers the expense of building a house. However, don’t make the mistake of assuming it’s like a mortgage. Construction loans are short-term, high-interest loans that may be paid off or transformed after a home is finished. They are intended to help those home seekers who don’t have enough cash to cover all the costs of building the home at the moment.
A construction loan is taken out via a lender — many lenders who offer mortgages also offer construction loans — but is paid directly to the contractor in charge of the project. The contractor is paid the loan in installments, typically as agreed-upon goals in the home building process are reached. This means that you must have a builder with a signed construction plan before applying for the loan.
Types of Construction Loan
What happens when the home is finished, but homeowners still don’t have enough cash to pay off the construction loan? One of two things can happen, depending on the type of loan it is:
Construction to permanent. In this case, when the home is finished and the construction phase officially over (often when the buyers move into the house), then the loan is swiftly transitioned to a true mortgage. It’s very important to know how the rates and payment period will change when this occurs – ideally, the rate will decrease to current mortgage levels when the switch happens.
Stand-alone construction. This construction loan cannot turn into a mortgage and must be fully paid off. Buyers are either very confident they can come up with the cash, or they are willing to take out a brand new mortgage on their newly constructed home to pay off the construction loan. Using a separate mortgage may have its own advantages if the mortgage market is particularly favorable, or if the buyers want some extra cash on hand for furnishing the home.
Benefits of Construction Loans
A construction loan is a very useful tool when building a home, especially because of those built-in milestones; they help to guarantee that a contractor will finish stages of homebuilding at specific dates, creating more accountability in the building process!
Interested in learning more about custom built homes, housing trends, and the right options for your housing plans? Contact us today at Hannah Custom Homes & Remodeling to learn more and arrange a meeting!