Types Of Construction Loans

Borrowers will need a construction loan if they want to purchase a home in a new development or to build a custom home. Construction loans are necessary because of the longer time frame and special requirements of the building process. 

There are three conventional ways to get your new home financed:

1. One-Time Close Construction Loan: It is also called an all in one construction loan. It is simplest way to go about building your home. Some points about it, are:

• In this type of loan, a lender provides both the construction financing and permanent financing in a single loan. 
• A One Time Close construction loan requires borrowers to sign only one set of documents.
• During the construction phase, periodic draw payments are made to the builder based upon work completed.
• It gives borrowers the option to either lock or float the rate.
• If your rate has been locked, you may have the ability to float down for a cost, typically one percentage point of the loan amount. 
• If you choose to float your rate, you'll need to contact the bank about agreeing on and securing the final note rate. 
• Typically, these loans allow for a maximum 12 month construction term, and may have penalties for going over.
• You are given the option to pay the interest on the funds that have been disbursed, or a regular mortgage payment. This varies from lender to lender.
• Monthly interest payments are made to the lender. At completion, the loan modifies to a permanent loan. 
• This type of loan offers a single close, and a single rate for both the construction term and the end financing. 
• The funds are released either by a draw schedule, or a generic punch list.                                                                                      

Advantages:

• A single lender is used throughout the process.
• There may be local and federal tax advantages of a single step loan.
• Closing costs duplication is minimized.
• The interest rate during construction and the permanent loan rate can be locked.

Disadvantages:

• There are fewer lenders providing this type of financing.
• Make sure the lender is experienced with the single step close loan. If the lender does not have the expertise, the process may be time-consuming and complex.
• Interest must be paid during construction. If you have a house to sell, this could result in cash flow strains during the construction period.                                                                                   Back

2. Note Modification Construction Loan: This loan looks a lot like the previous loan, but with a few unique features. Some points about it, are:

• In this option your new home is financed with a construction loan plus a note modification.
• There are often two separate rates. The first rate covers the construction term and the second rate is the end loan rate. 
• The construction rate is typically fixed during the construction term, and you'll be asked to pay interest on the amount that is disbursed based on that rate. As construction progresses, your payment will increase accordingly.
• The end loan rate can either be locked, or left to float with the market. This is up to you. 
• Once your house is complete, it is time to modify your construction loan. Modification is simply the process of converting your construction loan into a permanent mortgage. 
• There may be some costs associated with this. These costs are to establish your escrow accounts and pay for any outstanding interest or other fees that may have accumulated during construction.   Back

There is one closing at the start of construction and a second closing to refinance the construction loan into a permanent mortgage. 

Upon closing on your construction loan you'll begin making interest only payments to the lender, and just as before these payments will increase as construction progresses. 

Once your home is completed, you'll need to refinance your construction loan into a permanent mortgage.

Generally, you'll be able to get a lower rate on your permanent mortgage because you'll be working with a true refinance rate, not the rate based on a construction to perm loan. 

Another important point is that you won't be locked into an end loan amount. This is important to consider in case you have any cost over runs or upgrades.

Disadvantages:

• There are two sets of closing costs.
• Transfer or stamp taxes are not minimized.
• Construction cannot begin until all requirements for the take-out financing are completed.                                                         Back

So when you start shopping around for the construction loan, must go through all the available options thoroughly & choose the suitable one.

                                                                                                       Top