How Construction Loans Work
The simple definition of a construction loan is a loan used to build a home. A construction loan is very different from a typical mortgage loan. A construction loan may sometimes be more difficult to acquire than a traditional home loan, because there isn’t anything to be used as collateral for the loan. This in turn usually also means slightly higher interest rates on a construction loan.
Construction loans still offer different loan types as well as different financing terms. Typical construction loans include the 30 year fixed, 15 year fixed, 1 year ARM, 3/1 ARM, 5/1 ARM, 7/1 ARM, 10/1 ARM and interest-only loans. You can also get a short term loan usually one year while the house is under construction and then refinance into a lower interest rate term once construction is complete. This however requires two loan closing, in turn costing you two sets of closing costs. A more popular construction loan today is known as a construction to permanent loan. This type of loan only charges you 1 set of closing costs.
Before you get a construction loan you will have to get pre-qualified for the loan just like you would a regular mortgage loan. Also, just like a typical mortgage the better your FICO score and the more equity you have in the land you are building your home on will determine what type of interest rates and how much you can borrow.
Another thing to understand about construction loans is that you have to start making payments on the loan before your house is completed. This can be done by simply making the monthly payment or by setting up an interest reserve fund. An interest reserve fund basically pays your monthly payment for you while your land is being built. It’s not a free service however, this amount is added back into the loan. Basically the bank estimates how much your interest will be over a year and adds that amount onto the loan. This does however help the consumer if they are paying rent or another house payment while their home is being buit.
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I would love to have more information on construction loans. We just purchased some land and are going to build a custom home soon. I’m not even sure where to start when it comes to construction loans. Thanks for the great information, I’ll continue my research.
It seems hard to get a construction loan these days. Do you know of any banks who still do them in the Florida area?