What Is a Construction Loan?
If you have ever bought a house before, you have probably heard of construction loans. This type of loan is most commonly used by people who are looking to cover the costs of a home renovation. Here, we will talk more about how construction loans work and how to get one.
Let’s explain more about what is a construction loan that can as well be called self build loan. This type is a short-term loan and is commonly used to finance the costs of construction projects before you obtain long-term funding. A lot of lenders find construction loans very risky, so they tend to have higher interest rates in comparison to traditional mortgage loans.
How Does a Construction Loan Work?
As mentioned above, construction loans are short-term loans meant for home remodeling. They are usually taken either by homeowners or builders to renovate the house. The loan can be used to cover a variety of costs, including the cost of materials, labor, and overhead. But because the loan is short-term, the term lasts up to one year. After that, a borrower has the possibility to refinance the loan into a permanent mortgage or obtain a new loan that can help them repay the construction loan back.
What Is the Scope of a Construction Loan?
Many loans have subgroups to them, and construction loans have their own different types to them as well. They come in all shapes and sizes. Also, they range from short-term loans to long-term loans and everything in between. Because of that, construction loans can be used for anything ranging from small repairs to entirely new construction projects.
The size, amount, and types of construction loans available depending on the borrower’s financial situation, the type of project they want to undertake, and the lender’s lending criteria. We will give you some types of construction loans:
- Short-term construction loans. Commonly used to repair small projects that don’t last more than a couple of weeks.
- Quick loans for renovation. They are used to fast renovations, like fixing AC or updating the electrical wiring.
- Small business loans or SBA. Specially designed for small businesses to remodel or renovate or to use for many other purposes as well.
Types of Construction Loans
Now that you know that construction loans have multiple types to them, it’s important to know what exactly you are looking for before making any decision.
Here are some of the most common ones:
- General obligation loan (GO)
- Revolving credit facility (RFCF)
- Acquisition financing arrangement loan (AFA)
- Construction only loan
- Construction to permanent loan
- Owner builder loan
- Renovation loan
- End loan
- FHA loan
- USDA construction loan
- VA construction loan
When it comes to construction-only loans, they can be called two close construction loans as well, simply because they future two closing dates or two applications. This type of loan is usually viewed as a riskier option since there is a possibility that a second application gets turned down.
On the other hand, if you have a larger amount of cash but don’t want to put a down payment, then a construction-only loan can be a good option for you.
This type of loan can be called one-time closing also. They call it that because you will have a single application and closing day for the loan. In this form of loan, you can also get an FHA construction to permanent loan, USDA, VA, and also conventional versions.
If you do go for FHA construction to a permanent loan, there will be some issues that even the lender will inform you about. One of the issues that will arise is that construction loans don’t generally permit any form of down payment assistance, which can be a problem for some people.
Owner-Builder loan falls in the subcategory of construction to permanent and construction-only loans. This means that a borrower can act as a builder as well. The problem regarding this is that most lenders don’t allow the borrower to be their own builders. Only lenders that allow something like this are for borrowers that are builders by profession.
If you are considering this type of loan, make sure that you are a builder since otherwise, you will not get approved.
If you are only looking to renovate or remodel your house instead of building a new one, you might want to consider a renovation loan. There are some options when it comes to these loans since if you are looking to borrow up to 20,000$, you can get a personal loan. On the other hand, if your renovation is from 25,000$ and up, you can always turn to home equity loans or a line of credit.
Either way, whatever option you choose in the end, you have full control of how you spend your money and on what. This is because you manage your budget, the plan, and payments also.
As the name already implies, this is the loan that refers to your mortgage once the house is built.
So, once you take out a construction loan, you will use it to build your house, but once you are done repaying it, you will only have left your regular mortgage, which is known as the end loan.
What to Consider Before Taking Out Construction Loans
When it comes to getting a construction loan, there are a few things you should consider before applying. Here are some things you should do before applying:
- Research different loans. Always look for different types of construction loans. Not every type is going to fit your needs.
- Find the right fit. Once you do your research, choose the right one for your needs.
- Look for the needed requirements. Every type of loan has different requirements, so make sure you research the ones your loan type needs.
- Shop around. Make sure to compare different lenders to find the best deal.
- Check your credit history. Before you apply for any loan, make sure that your credit score is in good form.
- Get pre-approved. It may sound like a hassle, but you will know exactly how much you can borrow and for how long you will need to repay it.
- Gather the needed documents. Once you decide to apply, you will need to provide the needed documents to the lender.
- Apply for a loan. Once you finish all the steps above, you can apply officially for the desired loan.
Where to Get Construction Loans?
There are a few places where you can get construction loans. You can go to a bank, credit union, or loan company in your area. You can also get a construction loan online. Before you decide which place to get your loan from, make sure you fully understand what the terms of the loan are and what your borrowing limitations are.
Many of us dream of building our dream homes,’ but we all know it can be a long and expensive process. Thankfully in the last decade and more, we have construction loans available to use. They make our dreams become a reality and help us save some money as well.
In this article, we talked more about them and their types, how and where to get one, and as well what they are. We hope this helps you find the proper type for you and your finances.