How a Construction Loan Works

Find out how a construction loan works and how it can benefit you as a homeowner. We’ll cover the basics of construction loans and what you need to know before applying for one.

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What is a construction loan?

A construction loan is a short-term loan—usually about a year—used to fund the construction of your home, from breaking ground to moving in. With a BB&T construction-to-permanent loan, your construction financing simply converts to a permanent mortgage when your home is complete. During construction, you only pay the interest on your loan, and your payments may be tax-deductible. Disclosure 1 1 The information provided should not be considered as tax or legal advice. Please consult with your tax advisor and/or attorney regarding your individual circumstances.

How do construction loans work?

Construction loans are usually short-term loans that are used to finance the construction of a new home. They are typically used by borrowers who are not able to get a traditional mortgage. Construction loans are typically interest-only loans, which means that you only have to pay the interest on the loan during the construction period.

The loan process

Construction loans are typically short-term loans with a maximum of one year and have variable rates that move up and down with the prime rate. The rates on this type of loan are higher than rates on permanent mortgage loans. To gain approval for a construction loan, the borrower must first qualify for permanent financing.

Construction lenders typically require the borrower to have a down payment of 30 percent of the loan amount. In some cases, 20 percent will suffice. The down payment requirement is different from traditional mortgage loans because construction loans are not usually secured by collateral such as a home.

The loan process begins with the borrower applying for a construction loan from a bank or other lending institution. The borrower submits plans and specifications to the lender, who then arranges for an appraiser to estimate the value of the property after completion.

The lender scrutinizes the borrower’s financial situation to make sure they can afford the construction loan and the eventual mortgage payments. Once approved, construction begins and progress drawdowns are paid to cover each stage of work completed. Interest is charged only on the funds that have been drawn down, not on the entire loan amount.

When construction is finished, the borrower must pay off the construction loan with either a lump sum cash payment or by applying for a new mortgage to replace it. If you choose to roll your construction loan into your final mortgage, be aware that you will probably need to refinance at a higher interest rate when you do so.

Applying for a construction loan

To apply for a construction loan, you will need to submit several pieces of documentation. These include:

-A loan application: This will include detailed information about you and your finances, as well as the property you are looking to build.
-Proof of income and assets: Lenders will want to see that you have the financial ability to repay the loan. This may include tax returns, pay stubs, bank statements, and other financial documents.
-A credit report: This will give lenders an idea of your credit history and help them determine if you are a good candidate for a loan.
-Construction plans and cost estimates: You will need to have detailed plans for your construction project, as well as realistic estimates for the cost of materials and labor.

Types of construction loans

Construction loans are typically short term with a maximum of one year and have variable rates that move up and down with the prime rate. The rates on this type of loan are higher than rates on permanent mortgage loans. To gain approval, the lender will need to see a construction timetable, detailed plans, and a realistic budget for the project.

There are two main types of construction loans:

1) Construction-to-permanent: You borrow to pay for construction. When you move in, the loan converts to a permanent mortgage with monthly payments that cover principal, interest, taxes and insurance.

With this type of loan, you make interest-only payments during construction, and the full loan amount is due when you move in — meaning you’ll need cash or other financing to come up with the full amount.

2) Stand-alone construction: You take out two separate loans — one for the construction and one for the mortgage — and make two separate payments. With this type of loan, your interest payments during construction will include some amount of interest that is based on the expected rate for a permanent mortgage.

What are the benefits of a construction loan?

Construction loans can be a great option for those looking to build their dream home. With a construction loan, you can finance the cost of the land, the cost of the materials, and the cost of the labor. This can help you save money in the long run.

Drawbacks of a construction loan

Construction loans are a bit more complicated than a traditional home mortgage and come with some additional risks. For one, you’ll need to purchase private mortgage insurance (PMI) if your down payment is less than 20% of the loan value. Additionally, construction loans are typically variable-rate loans, so your monthly payments can go up or down depending on market conditions.

Another drawback is that construction loans are typically more expensive than traditional mortgages. In addition to paying PMI, you’ll also pay origination fees, appraisal fees and other closing costs. These costs can add up quickly, so be sure to factor them into your budget before you apply for a construction loan.

How to get a construction loan

Construction loans are typically short-term loans with a maximum of one year and have varying rates. These loans are used to pay for the construction of a home and the borrower is expected to pay off the loan once the home is completed.

Most construction loans are given out by banks or credit unions, but there are some companies that specialize in construction loans. There are also a few things to keep in mind if you’re thinking about getting a construction loan.

First, you’ll need to have good credit to qualify for a construction loan. The reason for this is because construction loans are considered to be riskier than traditional mortgages. Lenders will want to see that you have the ability to repay the loan before they approve it.

Second, you’ll need to have a down payment of at least 20% of the total cost of the project. The reason for this is because lenders don’t want to finance more than 80% of the project’s total cost.

Third, you’ll need to have a detailed plan and budget for your project. Lenders will want to see that you know exactly what you’re doing and how much it’s going to cost.

Fourth, you’ll need to find a lender who is willing to give you a construction loan. This can be tricky because not all lenders offer these kinds of loans. You may need to shop around or get referrals from friends or family members who have had success with construction loans in the past.

Finally, once you’ve found a lender and been approved for a loan, make sure you understand all of the terms and conditions before signing anything. Construction loans can be complex and there may be hidden fees or other things that you’re not expecting. It’s important that you understand everything before moving forward with your project.

Summary

Construction loans are typically short term with a maximum of one year and have variable rates that move up and down with the prime rate. The rates on this type of loan are higher than rates on permanent mortgage loans. To gain approval, the lender will need to see a construction timetable, project plans and a budget, as well as evidence that you’re qualified to manage a construction project.