If you’re building a new home or commercial space, chances are you’ll have to consider taking out a construction loan. Many homebuilders know how to get a construction loan and will take care of it for you as part of their services, but after the recession, the responsibility falls to the prospective owner more often than it used to.
It can be challenging to get good construction loan rates as an individual, especially if you don’t have previous banking history with a finished home to use as collateral. So how do construction loans work, and how can you acquire one?
Construction loans are governed by special guidelines and are very strictly monitored. Usually this is so you can begin repaying your loan as soon as your construction work is carried out. Most new construction loans are short term and max out at one year repayment terms.
Construction loan rates are variable and move with the prime rate. Construction loan rates are also higher than typical rates on permanent mortgage loans to allow for faster repayment.
In order to approve the loan, your lender usually needs to see what’s called the “story” behind the loan. This includes a detailed timetable, budget and plans for the construction. Many real estate brokers will also want to see a proof of income, tax returns, documentation of any debts, and/or a 10% down payment. Commercial lenders may be more interested in how much revenue the property is expected to bring in. Most lenders, both for commercial and private real estate loans, look for a credit score of 680 or better when deciding to approve or not.
If the loan is approved, a schedule will be set out for the borrower to repay the loan following the stages of construction. You should schedule some flex time for whether and material shortages that could extend the process. Usually only interest payments need to be paid off while construction is still ongoing.
When constructions are complete, the loan usually rolls over into a mortgage in a way that the borrower only has to pay closing costs once. This is often called construction-to-permanent financing and the loan period is usually about 30 years.
Usually regional banks and credit unions are your best bet for finding construction loans.