Definition of a home loan
As the name suggests, home loans or construction loans help people build their dream home. They can also help with home renovation projects.
These loans differ from traditional mortgages in their terms and approval process. A home loan generally has a shorter term than a traditional mortgage loan used to purchase a resale property.
Interest rates also tend to be higher. There is a lot to know about construction loans. We dive into what makes home loans different from typical mortgages and how they can help you achieve your goals.
This is how construction loans work
New home loans can be classified into two main categories namely Qualification and Loan Disbursement. Let’s look at some important details before you take out a construction loan.
It is important to note that in order to obtain this type of financing, you must go through a similar mortgage approval process as you would with a resale property.
Lenders want to know that you have good credit, verify your employment, and make sure you have an adequate income to fund the loan.
The property must also undergo a real estate appraisal by a professional appraiser to ensure fair value.
Collateral, architectural plans and builder requirements
If you take out a new construction loan to build your own home, you do not have to have any collateral like with a classic mortgage loan. This makes the loans less stressful.
However, borrowers must meet certain requirements before loans are approved and disbursed. In principle, construction plans must be checked as well as the respective builder and the finances of a borrower.
Paying off a loan differs from a traditional mortgage
A home loan is also paid out differently. Instead of the traditional loan disbursement, in which a lump sum is transferred to a borrower at closing, lenders pay out the money in installments (known as draws).
Each installment coincides with an important construction phase. For example, when the foundation is poured, a designated bank inspector will check that the work is complete.
When the frame is ready they will do the same. A bank representative reviews each of the major construction phases before funds can be released to either the builder or the homeowner.
The amount of the remuneration is also based on the completed work shown in the construction inspection report.
Types of home/construction loans
Here are 3 types of home loans to help you find the best one for you.
I. Home loan
This type must be paid back in full after the house construction is complete. You must qualify and pay the closing costs after you are approved to get a home-only loan.
A home loan only is perfect if you have a substantial cash reserve or want a permanent lender during the construction phase.
II. Renovation Building Loan
As the name suggests, this type is taken for renovation purposes. Home renovations can be expensive. With a home improvement loan, the cost is packaged into a mortgage loan rather than being funded upon completion.
Renovation home loans typically vary based on the home’s value after the renovation is complete. These loans should be taken out by people who do not have enough money for renovations.
III. Build to Term Loan
This type of home loan converts into a permanent mortgage after the home construction is complete. They have a fixed interest rate at closing and work perfectly when the blueprint is known and borrowers value predictable interest rates.
Most buyers building their home will look for this type of financing.
home loan coverage
While the scope of home construction varies, home loans generally cover the cost of land, permits, plans, labor and materials, additional costs (if the projected costs are estimates), and interest reserves if you don’t pay interest during construction want.
Get a construction loan
As with mortgages, you must meet certain requirements. The most important would be if you had a credit score above a certain range. You must also have a reasonable debt to income ratio. A deposit may be required. However, this differs depending on the lender.
Ideally, your debt shouldn’t be more than 0.45 of your income. Most home loan lenders require a credit score of 680 or higher. Most lenders require a 20-30% down payment for a new home loan. Requirements vary by lender.
Choose a home loan lender
It’s best to focus on mortgage lenders that offer construction loans. In addition, they must have favorable prices and conditions. It also helps determine if you can get a loan with your current credit score.
Since building a house can be tedious, financing should be chosen with care. Focus on lenders that perfectly manage borrower and builder expectations. Experience is crucial when choosing a construction lender as such lenders guide borrowers with minimal frustration.
Experienced lenders also understand the needs of borrowers and have developed streamlined processes. If you qualify for a loan from such lenders, you can be sure that it is affordable and has other favorable terms.
If you want to buy land and build the house at the same time, a construction loan is the best option. Hopefully you now have a much better understanding of how construction loans work – good luck with your new construction project.
This article was submitted by an outside contributor and may not represent the views and opinions of Benzinga.