This Is How Home Construction Loans Work

Whether you are looking to build your home from scratch or renovate or remodel an existing home, you need to be familiar with home construction loans. Although you may be familiar with a traditional mortgage loan, construction loans differ in several key aspects. 

A construction loan is a short-term loan to finance a home’s construction, rehabilitation, or renovation. From how these loans work to the types of construction loans to how to qualify, it is essential to understand the intricacies of these loans before you embark on your home construction project.

Keep reading to learn everything you need to know about home construction loans, then call us at Schar Construction for a detailed estimate of your project costs and get the ball rolling on your new home!

Understanding the Basics of Home Construction Loans

Short-term construction loans cover all of the costs associated with your project, including the costs of the following:

  • Land
  • Plans and permits
  • Materials and labor
  • Appliances and fixtures
  • Landscaping

Instead of receiving your loan as one lump sum, your lender will make several payments throughout the loan term to your construction company directly at key milestones in the project. A construction loan differs from a traditional mortgage loan in significant ways:

  • They are generally not covered by collateral
  • The duration is limited to the time of construction (usually 18 months or less)
  • The interest rates are usually variable and higher than a mortgage
  • The loan is distributed in phases rather than in a lump sum, and inspections may be required

In addition, payments on your home construction loan generally include only the interest on the amount dispersed during the build.

Types of Construction Loans

Several types of home construction loans are available to suit your particular need. Here is an overview of the most common loans:

  • Construction-only loan: A construction-only loan covers the cost of building the home. The lender disperses the money in phases as the construction project progresses. You must pay the interest on the money distributed during construction and pay the balance in full when the building is complete.  
  • Construction-to-permanent loan: This type of loan begins as a construction-only loan and then converts to a traditional mortgage loan once the construction project is complete. The advantage of this type of loan is that you are only responsible for closing costs and fees on a single loan. 
  • Owner-builder loan: These loans are available in limited circumstances. Generally, the borrower is a professional builder. These loans can be either construction-only or construction-to-permanent loans. 
  • Renovation or Rehabilitation Loan: Your mortgage typically includes the amount to renovate or rehabilitate if you are purchasing a home for that purpose. If you are remodeling your existing house, look for a home equity line of credit or a traditional loan instead.  
  • End Loan: An end loan involves a construction loan that you pay in full at the time of completion. You would then have an “end loan,” a traditional mortgage loan on the property. This is an alternative if the lender does not offer a construction-to-permanent loan. The obvious disadvantage is that you will have to pay the fees associated with two loans. 
  • Land Loan: A land loan covers only the costs associated with purchasing the land upon which you wish to build. 

Qualifying for a Home Construction Loan

You can take several steps before applying for a home construction loan that will make the entire process smoother. First, before approaching a lender, you should research if you are eligible for any special construction loan programs, through the Veterans or Federal Housing Associations, for example. Second, it is also wise to seek pre-approval to get a realistic idea of your available budget. 

Although lender requirements vary, when it comes time to submit your application, you can expect the lender to ensure you meet the following requirements: 

  • Financial Standing: You should expect your lender to check your credit history. Your credit score should be 680 or higher to qualify for the best interest rates. You will also need sufficient proof of income, including an income-to-debt ratio sufficient to make payments.
  • Down Payment: When you get approval, you’ll make a down payment. Construction loan lenders generally require 20-30% of the loan amount as a down payment. Any less, and you must purchase private mortgage insurance. If you own the land, it may be possible to use the equity as your down payment.  
  • Budget: A detailed line-item budget improves your chances for approval by demonstrating to the lender the reasonableness of the intended project. 
  • Plans: Be prepared to have your architect and construction company present their licenses, resumes, insurance documents, blueprints, and scheduled build time. 

Selecting a Home Construction Loan Lender

When looking for a home construction loan provider, look for lenders with experience in home construction loans. If you have a long-standing relationship with a bank that regularly offers construction loans, that is a great place to begin. However, remember to see if you qualify for special loan offers, as the savings could be significant. 

Selecting a loan with terms that work best for your situation is the guiding principle in choosing a lender. As with any investment, you must understand the terms completely. Make sure to talk to your lender about each of the following topics:

  • Do they offer the type of construction loan that you desire?
  • How much downpayment is required?
  • What is the interest rate, and is it variable or fixed?
  • How do they determine and schedule repayments?
  • What are the closing costs and fees?
  • What are the disbursements based on: percentages or milestones?
  • What are the procedures in case of delays or unforeseen price changes in materials?

At Schar Construction, our team has 47 years of experience building homes in Eugene, OR, and surrounding areas. We have a wealth of experience with home construction loans and will comply with the lender’s requirements, meet deadlines, stay within budget, and exceed your expectations. Call us today at 541-203-6342, and take the first step toward your dream home!

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