Having a house to call your own is a delight but the process of doing so is surely not something one would particularly enjoy. From taking up loans to finalizing plans, erecting your dream home is no joke, my friend. Before we begin with the facts let us be sure to be on the same page regarding what we know about construction loans.
A construction loan is usually a short-term loan that can be given by any bank or financial institution that covers the cost of constructing a house. It is usually offered for a fixed period of time to a borrower (about a year). The borrower has to pay interest during the construction period.
How to qualify for a construction loan:
Bankers and financial institutions do not just give loans to any interested party; they will only lend you the money when they have the faith that your construction will attain a certain value when it is finished. To avoid making poor investment bankers set a strict bar for qualifying for a loan.
- Qualified builder: If the institution does not have faith in your choice of builder the chances are that you won’t be getting a loan. The builder must be a reputed one with a government license capable to provide quality service.
- Detailed specification: The lender will be asking for a detailed specification for each and every act involved.
- Value estimation: The future value of the home should be estimated and stated before starting with the project.
Five Facts about down payment:
- A requirement for a large down payment: Lenders ask for a minimum of 20% of the amount of money of loan taken by the borrower. Often lenders go as high as 25% of the loan amount in order to make sure that the borrower has invested in the project and that he won’t walk away from it if anything goes wrong. Also, it gives the lender a certain amount of security if in case the property value doesn’t turn out as expected.
- Loan to repay a loan: One of the most important features of construction loans is that the borrower has to take up another loan at the end of the construction period in order to pay off the money borrowed. The loan taken to pay off the construction loan is called an end loan. As the construction loan is a short-term loan it should be paid by taking up a permanent long-term loan. An end loan can be an interest-only loan that can result in paying the interest and not the principle or it can also be a normal loan that requires payment of both interest and principle.
- Not qualify for an end loan: Some people might take it for granted that at the end of the construction loan for the repayment they will easily be getting a second permanent loan. But if your income or credit drastically changes during the loan period the bankers might not be comfortable in giving you another loan. In this case either you have to pay the short-term loan from your savings or the bankers will shut your project down by refusing to provide to refinance somewhere else and ultimately resulting in you losing your home.
- Loan rate: Construction loans are usually variable rate loans where your interest rate changes according to the outstanding balance and market rates. Also, the interest rate is usually calculated as prime rate plus a certain amount. For example, if the prime rate is of 5% and 2% is the added rate, the borrower has to pay an interest of 7% on his principle. Construction loan can also be an interest-only loan in which one pays only the interest on the loan and not any part of the principle.
- Builders receive in draws: The lender in order to minimize risk doesn’t pay the builder the total sum of money in advance or all at once. In certain designed intervals the builder receives his finance to carry on with his project. Usually, the first draw comes from the buyer’s first down payment after the loan closes. The next draw can come after the foundation is poured and the process carries on, making sure that no funds are misused during the process.
Make sure you have your finance sorted and have a good reserve before you start with this risky business of construction loan.