Construction loans are very different than standard mortgage loans. There is much more than just approving the borrowers credit, assets and liabilities. The project itself must be approved as well.Construction loans are usually short term interim loans for covering the cost of construction. The lender pays funds to the builders at predetermined times based on the progression of the project.
With a construction loan the builder will receive pre-established draws at certain stages of the construction. You will normally begin making interest only payments on those draws as construction continues. You will only pay on the money that has been give to the builder, not the total amount. By the lender providing predetermined draws to your builder, this helps protect you the buyer that your builder doesn't just run off with all of the funds and stop building your home. Usually inspections will need to be done at the predetermined stages to make the sure the work that is supposed to be done is completed also before providing the builder with the next draw.
Construction loans generally can be done with a one time close before construction commences on the proposed property or with a two step closing done. Rates are usually locked for approximately 6-12 months on a construction loan. The longer the rate lock however the more the rate lock will cost though for a construction loan.
Construction loans have higher upfront costs than a standard conforming mortgage. The lender views these loans as higher risks with shorter terms and in return charge more money up front to close.
Most construction mortgage lenders stipulate that the contractor or builder be experienced in building the subject property. Many lender banks require a list of similar type of homes the builder constructed as part of underwriting documents.
Construction loans are sometimes variable-rate loans priced at a spread to the prime rate or some other short-term interest rate. You, the contractor and the lender establish a draw schedule based on stages of construction, and interest is charged on the amount of money disbursed to date.
Some homeowners use construction-to-permanent financing programs where the construction loan is converted to a mortgage loan after the certificate of occupancy is issued. The advantage is that you only have to have one application and one closing.
With some construction to perm financing or known as the one time close you will have a variable rate during the construction phase. It then converts to a fixed rate longer term loan like a 20 or 30 year fixed rate. And there is usually a cap or stop point on the adjustable time period of the construction phase. This cap is set according to how long the building phase will last. For instance if you only need 6 months you might have a cap of .5% which means your rate for your permanent financing will not go any higher than 1/2% of your start rate.
