A construction loan is also called a self-build loan. This is a short-term loan that finances a real estate project like home building. The home buyer or builder takes out this loan to cover project costs before they get long-term funding. Since a construction loan is considered fairly risky, its interest rate is higher than that of a traditional mortgage loan.
How Construction Loans Work
Home buyers and builders that want to custom build homes take construction loans. These are short term loans payable within a year. Once house construction is complete, borrowers can opt to refinance their construction loans into permanent mortgages or borrow new loans for paying of their construction loans. These are also known as the end loans.
Borrowers may be required to simply pay interests of their construction loans while their projects are underway. In some cases, construction loans require payment of the balance entirely by the end of the project.
If a borrower that wants to construct a home takes a construction loan, a lender may pay funds to the contractor directly instead of giving them to the borrower. Payments can be made in installments depending on new development stages. Construction loans can be used to finance restoration and rehabilitation projects and building of new homes.
It’s important to note that you can use a construction loan to build your dream home. However, this loan has a larger down payment and higher interest rate than a traditional mortgage.
In most cases, lenders require borrowers to make a minimum down payment of 20% on their construction loan. Some require up to 25%. A borrower can therefore find securing this loan difficult especially if their credit history is limited. Getting the loan approved can also be a challenge because a borrower may not have collateral.
Most borrowers require lenders to provide all construction details or the blue book. A borrower has to prove that the project involves a qualified builder. Regional banks and credit unions offer construction loans. Banks are knowledgeable about housing markets. Therefore, they are likely to lend borrowers within their communities.
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