Home Improvement

Understanding Construction Loans

More and more people are choosing to hire a construction company to build a home. It is the best way to get a house in a location of your choosing and to have more control over the layout and everything else. To afford this, there are a number of loan opportunities you might consider such as a refinance home loan to fund the build or you might want to look into construction loans.

Outlining a construction loan

A construction loan is an interim short-term loan to finance the construction of a new property. The credit provider or lender will give you a mortgage on the property you are getting a loan for and they make payments to the builder over certain intervals at different stages of the construction progress.

How it works

When you are looking into getting a construction loan the lenders have different requirements and different policies to get approval and to process the loan application. If approved they will fund you in three ways. They will give you the loan amount you need to buy the land the property is going on for the construction costs. If you have already borrowed to buy vacant land then the first loan payment amount from the lender will go to paying off that. Then the amount left breaks down into ‘progress payment drawdown’ totals. This means at certain stages of completion the builder will receive a progress payment.

What is the structure of a construction loan?

Construction loans are somewhat similar to mortgages but there are a few differences which include;

  • Construction loans tend to be short term, often a maximum time is one year.
  • Interest is only worked out and applied to the loan figure that has been drawn down.
  • Interest is only paid during the construction period.
  • The construction must start within 12 months from the loan settlement.
  • From the first progress drawdown payment, the 12 months of construction begins.

Stages of progress payments

Before a lender pays progress payments of the construction loan to the builder they will arrange valuations. The stages of payments are as follows;

  1. To pay for the plot of land you want to build on
  2. After the builder has layed the flooring
  3. After installing the roof frames and roofing
  4. At the lock-up stage, the walls, windows and doors are up and the property can be secured
  5. When the build is complete. At this point, the loan moves from a construction loan to a standard home loan.

Documents required

In order to apply for this loan, the lender will need to see the plans and specifications that have council approval and a building contract that is fixed price. 

Summary

When you are comparing loan options such as say a refinance home loan compared to a construction loan, you will see the former is when you refinance the mortgage on a home you already own. You are basically taking out a new mortgage on it and trading the old mortgage. The old mortgage gets paid off by the lender with the new mortgage. You can lower the interest rate you are paying and consolidate your debt.

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