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Construction Loans

May 27, 2008  |  Difficulty: Easy

Path to mortage
A construction loan is used to make your home exactly the way you want it, but it will take some work.

You will need to have a solid idea of how you envision your newly built home. Before you get a construction loan you must tell the story to your lender of how you plan to construct your future home. That is why a construction loan is often called a “story” loan. You need to convey your idea in such a way that the lender knows exactly how the loan will be used, before giving you the money.

You will need documents while telling your story, to let the lender know that you do have a solid idea. The documents can be floor plans that you have discussed with a builder or contractor. You will need to show that you have already purchased the property on which the house will be built by allowing the lender to see the deed. These documents will help you explain your plans, and will allow the lender to see that you have taken the steps to ensure that your plan is carried out successfully.

There are two aspects of a construction loan that you should know about. Interest-only payments are required during the construction phase, and the interest payments are due once the construction is finalized and the home has been given a certificate of occupancy by the municipality. 

The construction loan will typically have a variable rate that can change over time. To keep the interest rates from becoming too high, you may want to set out a construction schedule within your loan contract. This will benefit you because the money that you have in-pocket to pay out for interest will vary during the construction period. Your interest payment will be based upon how much money you have borrowed. 

Most lenders will not give you a loan that will cover all of the cost needed to build your dream home. But if you own the land that your house is being built upon, the equity of that land can be placed on the construction loan. 

One major advantage of construction loans is that it can be turned into a mortgage after your home is given the certificate of occupancy. This means that you will only need one set of paperwork for closing. But to qualify for this type of loan you will need to have a good amount of equity.

Why is it beneficial to convert a construction loan? Simply put, it can save you time and headache that comes with too much paperwork and too many contracts. The construction loan is typically used for a shorter period of time, which is the time it takes to build the house. Since the building process takes only a year or so, the interest rate isn’t too much of a big deal. But if you plan on converting the construction loan into a mortgage loan, the interest rate is in fact very important. A high interest rate on a 6-month construction contract can mean the payout of an extra $250, but a higher interest rate on a construction loan that will be turned into a mortgage can mean the payout of thousands of dollars over time.

If you are not able to convert your construction loan into a mortgage, you can negotiate a mortgage loan with the same lender or seek the services of another lender. Make sure you take the time to find what is best for you.

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