Construction loans are loans that are used by builders or individuals who want to build their own homes from start to finish. Construction loans can be used to pay for the costs of buying land, drafting building plans, securing permits, and paying for materials and labor. These loans are typically issued for 12 to 18 months. If the land has previously been purchased, it can be used as collateral for the loan.
How Do Construction Loans Work?
A conventional mortgage is a loan taken out to buy a completed home. A lump sum is provided to pay for the home and the buyer pays a monthly premium and interest payments over the long-term life of the loan. A construction loan is more complicated because the funding for construction is paid out in installments as the phases of the home construction procedure.
The various types of construction loans include:
• A construction-to-permanent loan where the loan pays for the home construction costs and then converts the loan into a fixed-rate mortgage when construction is completed.
• A construction-only loan where the loan is issued solely for the construction of the home. After the home is completed, the loan must be repaid in full or refinanced into a conventional mortgage.
• An owner-builder loan where the loan payment installments are made to the owner-builder (if the borrower-builder has construction experience.)
What is Required to Get a Construction Loan?
Construction loans typically have these requirements:
• Good-to-excellent credit.
• Enough dependable income to pay off the loan.
• A low debt-to-income ratio.
• A down payment of 20 percent or more.
• Project and construction budget approval.
• Builder or general contractor approval.
Choose a lender that has a good reputation. Ask what types of construction loans they offer and what interest rates they apply.
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