A construction loan or a building loan is a short-term high-interest loan that finances the cost of building or renovating a building for residential or commercial purposes. The lender pays the loan directly to the contractor and not the borrower. The contractor receives the money in installments depending on the building milestones.
A construction loan is more than a mortgage in that it covers more than just purchasing a house. When the building is complete, the lender and the borrower may agree to convert the loan into a mortgage or let the borrower pay it in full. Click here to know ways you can finance your investment property using construction loans.
Funding the Property Purchase
Before a lender can give out a construction loan, they will want to see the land where the building will stand. As a result, some people opt to buy the land from their savings or secure other forms of loans from banks and other financial institutions. However, the purchase loan lender ends up as the construction loan lender in most cases.
You can access a construction loan from a bank to purchase land and receive construction financing, but that will depend on your credit history and architectural plan. To add to that, if you present an excellent plan, you have a chance of receiving land and construction financing from the same lender and at a lower cost than borrowing from two separate bodies.
Accessing Building Financing
Once you acquire the land, you now apply for a construction loan. Most building financing bodies offer eighty percent of the total cost of construction. The lender calculates the price according to the plan that you present.
You can put up the remaining amount as a deposit in cash, though many investors prefer to use the land as collateral to meet the bank’s requirements. For example, suppose you secured a loan before with a piece of land; the bank will turn it into a construction loan. During the construction period, the loan will be “interest-only.” The interest payable will continue to increase until permanent financing is in place.
Permanent Home Financing
You can convert the construction financing into permanent or construction-to-permanent loans when the contractor completes the work, and the building is standing. If you flip the loan into permanent, It becomes similar to a permanent mortgage that can be paid in equal installments over a long time.
Though you do not have to use the same bank with permanent financing, it would be better to do so as it will be cheaper. In addition, the bank is likely to consider the existing relationship and spare you additional charges of attorney fees and closing costs. However, the process of permanent financing is similar to purchasing an existing home.
Renovation, Construction Loans
You can use construction loans to remodel your home to your liking. However, the renovation cost counts in the mortgage rather than the financing after the sale. Therefore, the loan will depend on the property’s value after repairs and renovations. The loans are more realistic if you have a fixer-up but lack renovating cash.
A Final Thought
When considering construction, it would be wise to do thorough research beforehand. Ensure that you are familiar with the procedures. If you hit the ground without the necessary information, you may find yourself at the losing end.