Did you know that over a million housing projects have been completed this year alone? It’s important to remember that almost none of these buildings could be completed without the help of a construction loan.
A construction project requires a lot of capital, and these loans are key to getting your building up and off the ground. But exactly how does a construction loan work? And how do you go about obtaining one?
If you want to learn the answer to these questions, and more, you’re in the right place. In this guide, we’ll provide you with all the ins and outs of finding the right construction loan for your needs.
What Is a Construction Loan?
A construction loan is a short-term loan that typically comes with higher interest rates. The money you get from this loan is used to complete residential construction projects.
Why are the rates that come with construction loans typically much higher than traditional mortgage rates? Because when you take a loan on a pre-existing house, the property is used as collateral in the event that you are unable to pay it back.
With a construction loan, the lender doesn’t have the ability to seize the property. As a result, they charge more with a higher-interest loan for borrowing the amount of money you need.
The specific amount of time for a construction loan is usually around one year, but it’s common to see them last the length of construction. Construction loans are dependent on the project actually being completed. Because of this, lenders tend to require plans that are detailed in terms of the budget and construction timeline.
Different Types of Construction Loans
There are multiple types of construction loans you can choose from. The first is a construction-only loan. This type of loan only covers the cost of building the home.
Alternatively, you can choose a construction-to-permanent loan. This loan covers the cost of construction. Then, when the home is completed, it transitions into a traditional mortgage.
If you want to construct a specific improvement (like a pool or ADU), consider a renovation loan. These are also good if you have a dilapidated house you’re trying to make livable.
Owner-builder construction loans are for contractors that are both the borrowers and the builders.
How Do You Get a Construction Loan?
You can break down obtaining a construction loan into four basic steps:
First, you’re going to want to find a qualified builder. Don’t jump the gun and look for a lender before you have a builder.
Your lender is going to want to know who is in charge of the project, and how much experience they have with construction. If you have a network of potential builders, you can reach out to them. If you don’t know anyone, we recommend checking out local associations through the National Association of Home Builders (NAHB), but make sure you compare builders before selecting one.
Second, you need to get your documents together. Most important is a contract between you and the builder that lays out a detailed plan and estimated pricing. You should also gather some references on the builder you choose. In addition to this, you will need traditional loan financial documents such as tax returns and pay stubs.
Third, it’s time to get pre-approved by a lender. This is important because it allows you to know exactly how much you’re working with your budget. It will determine who you can hire for the project.
Lastly, invest in homeowners insurance. Even though the home isn’t built, some builders’ risk coverage on your policy will ensure that everything is covered in the event of an accident during construction.
Factors to Consider When Choosing a Loan
The first factor you should consider when choosing a construction loan is whether or not you’ll face potential timeline problems. Expensive materials due to inflation, supply-chain problems, and shortages can all slow down the pace of your project, so make sure you work with your contractor closely to account for them.
Next, make sure you understand the drawing process behind your loan. This is how lenders distribute the loan money, and it can differ based on the provider. Some lenders allow you to draw on a monthly basis. Others will require you to pass an inspection before they issue the draw.
Making sure both you and the contractor understand the drawing process will save a lot of headaches later on.
How to Find a Construction Loan Lender
It’s important to compare rates between different loan providers to make sure that you’re getting the best rate possible.
A quick Google search of loan providers in your area should turn up some needed results. Make sure you choose a provider that specializes in these types of construction loans. Construction loans are a lot more complicated than mortgages, so you want to make sure you aren’t getting someone that’s completely new to them. The more years they’ve been in business, the better your odds are of getting a fair loan that fits your construction needs.
Need a Construction Loan? Contact MMTC
We hope this article helped you learn more about obtaining a construction loan. Here at Merchants Mortgage, we know how important timing is when it comes to the needs of the real estate market.
With construction, one tiny delay can throw off an entire project. That’s why we specialize in offering short-term residential bridge loans for investors in tight positions.
We also provide fair terms for rental property loans, commercial loans, and construction loans that you can get quickly to meet the needs of your project.
So if you’re ready for the financial support you need, contact us today.
