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Construction Loans

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Ruben Garcia Mortgage Group - Construction Loan

What’s a construction loan?

Building a brand-new home to your exact specifications may sound like a dream come true, but home development can get pretty complicated, especially if you need to take out a loan to pay for it. Its important that you do your homework and ask a LOT of questions.

From good credit to construction timetables, here’s everything you need to know about home construction loans.

A construction loan is a short-term, interim loan to pay for the building of a house. As work progresses, the lender pays out the money in stages. Construction loans are typically short term with a maximum of one year to five-year terms and have variable rates that move up and down with the prime rate. In most cases you can get a 3/1 ARM loan which will give you the peace of mind in knowing your rate will not fluctuate during the first 3 years. The rates on this type of loan are higher than rates on permanent mortgage loans. To be considered for an approval the lender will need to see a construction timetable, detailed plans, and a realistic budget and contractors’ information. Lenders will typically not allow the borrower to also be the contractor on the same project.

Once approved, the borrower will be put on a bank draft, or draw, schedule that follows the project’s construction stages and will typically be expected to make only interest payments during construction. As funds are requested, the lender will usually send someone to check on the job’s progress. These funds will not go directly to the borrower, instead they will go to the contractor, sub-contract, developer, etc.

There are two main types of home construction loans

1. Construction-to-permanent loan

Under a construction-to-permanent loan, you borrow money to pay for the construction costs of building your home. Once the house is complete and you move in, the loan is converted into a permanent mortgage (like a traditional 30 year loan).

Because this format is basically a two-in-one loan, you have only one set of closing costs to pay, reducing the number of fees you owe. However, the downside is that the rate may be a little higher.
During the construction of your house, you pay interest only on the outstanding balance; you don’t have to worry about paying down the principal yet. Typically, you’ll have a variable interest rate during the construction phase, so the rate and your payment can fluctuate.

Once it becomes a permanent mortgage — with a loan term of 15 to 30 years — then you’ll make payments that cover both interest and the principal. At that time, you can opt for a fixed-rate or variable-rate mortgage.

Ruben Garcia Mortgage Group - Construction Loans

2. Construction-only loan

With the construction-only loan approach, you take out two separate loans. One is solely for the construction of the home, which usually has a duration of a year or less. Then, when you move in, you take out a mortgage loan to pay off the construction.

With a construction-only loan, you don’t need as large of a down payment. This can be a smart option for those who own a home and are building their next house. You may have limited cash now, but once your current home sells, you’ll have more money to pay the mortgage on the completed house.

However, construction-only loans can cost you. Because you have to complete two separate transactions, you’ll pay two sets of fees. And, if your financial situation worsens, such as if you lose your job, you might not be able to qualify for a mortgage to actually move into your house.
What construction loans cover.

A construction loan is used to cover the costs of work and materials for new build homes. Some of the items you can finance with a construction loan include permits, contractor labor, home and roof framing costs, interior finishing costs and many of the other expenses involved in building a house.

How to get a home construction loan

Qualifying for a home construction loan is typically more difficult than qualifying for a traditional mortgage. With a traditional mortgage, your home acts as collateral. If you default on your payments, the bank can seize your home. With a home construction loan, the bank doesn’t have that option, so they view these loans as bigger risks.

To offset that risk, home construction loan lenders tend to have more stringent requirements. To qualify, you’ll likely need:

  • Good to excellent credit
  • Stable income
  • Low debt-to-income ratio
  • A down payment of 20 percent or higher depending on the size of the loan.

The lender will also want detailed information about the lot, planned house size, materials used, and what contractors will be working on the home. Working with a reputable general contractor can make gathering this information and navigating through the process easier.

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20%

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4.375%

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Want a Copy of the Results?

$1421

Monthly Payment

Principal & Interest $1421

Monthly Taxes $1421

Monthly HOA $1421

Monthly Insurance $1421

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