Disadvantages of Construction Loans

By | May 8, 2019

Disadvantages of Construction Loans

Construction loans have their advantages and disadvantages. These loans are interest-only loans. That means you won’t pay the loan in full until you complete your new construction. What’s more, their terms are flexible and their added scrutiny gives the construction project a structure. But, like anything else that has advantages, construction loans have their disadvantages too.

Here are the major disadvantages of construction loans:

Qualifying for Construction Loans is Not Easy

Construction loans are very flexible. However, their qualifying standards are relatively higher in terms of down payment and credit. Typically, you need a minimum score of 680 to qualify for a construction loan. You also need make a minimum down payment of 20%.

Construction Loans have Higher Interest Rates

Typically, the interest rates of construction loans vary. This variation corresponds to prime rate percentage or the rate that is given the best customers by banks. For instance, when the prime rate hits 4% and the rate for your loan is a prime plus 2%, the bank expects you to pay 6%.

Construction Loans are considered a Risk

Banks consider construction loans a risk especially when a borrower needs a construction-only loan. Once the term of your loan ends, you should pay off your loan fully. If you take this route, ensure that you can pay off your loan even if the original financing ends up falling through.

A mortgage company pays a traditional loan to cover home cost in a lump-sum at closing. On the other hand, payment of construction loans is done in installments. The bank pays the builder at different phases of a construction project once completed. The total construction cost is then transferred to the borrower after the project is completed.

Installments are known as draws. Every draw reimburses a builder for every phase of the construction. That means you or the builder should have sufficient cash to cater for the construction project upfront. What’s more, the lender will inspect the completed phase to verify the cost and how well the project is been handled within the agreed timeline.