Construction Loan

Construction loans are story loans, which means that the lender actually has to know the story behind the construction that is planned, before they will be willing to lend you the money. Story loans are not standardized like mortgage loans are when underwritten to Freddie Mac and Fannie Mae guidelines. There are common features to a construction loan as well, though. Construction loans tend to require interest-only payments during the construction, and become due upon completion. In order to be complete, it means that the house must have its certificate of occupancy.

Construction loans tend to be variable-rate loans that are spread to the prime rate, or to some other short-term interest rate. Both you and the lender will establish a draw schedule together, which is based on the stages of construction, and interest will be charged on the amount of money that is disbursed to date.

Another important variable in construction loans, is how much of the project cost the lender is actually willing to lend. If the land is already owned by you, it can be considered as equity on the construction loan. Construction-to-permanent financing programs are popular among many homeowners, meaning hat the construction loan will be converted into a mortgage loan after the certificate of occupancy is issued for the completed building. The advantage of this type of loan program is that there is only one application, and only one closing.

You could also purchase a rate-lock agreement, depending on your view on trends in interest rates. These rate-lock agreements can be valid through the expected completion of the construction, but you should make sure to allow for inevitable construction delays to ensure that the rate-lock agreement covers the entire length of the construction.

Construction loans, unlike mortgages, are not actually meant to be around for a long time. If you plan on taking out a $200,000 construction loan for six months, and plan to pay an extra 0.5 percent on the loan, it will cost you an additional $250 in the end. This assumes an average of $100,000 loan balance over an approximately six-month period of construction. You may be willing to pay higher rates on a construction loan, if you are doing a construction-to-permanent financing, which can give you better mortgage terms, or a better, longer rate lock from that lender.