Construction Loans 101


How is a new or significantly remodeled house financed before construction has begin? This is an important question when a buyer has purchased property but hasn't begun construction yet. Development costs are generally paid with something known as a construction loan. These (owner or builder loans) help cover most of the construction activities. Let's take a look at common questions about this financing option!

What is a Construction Loan?

(Owner and builder construction loans) are loans made through a lender, where the owner pays the loan payments and the lender releases money for the builder to spend on construction.

The loan is typically released in phases called draws, after the builder has reached each milestone according to a contract signed with the owner. This helps hold the builder accountable to the specific terms of the contract and its deadlines. Usually, interest is only collected from funds that have already been drawn, although this can vary.

These loans are a vital part of new construction because they allow the owner to finance a new house without needing the cash on hand. They can also be used for very large renovation projects.

What Do Construction Loans Cover?

They can cover the purchase of the land – if that has not already been addressed – all labor, all construction materials, and any related permits, fees, architectural designs, or similar requirements. The loan will also be used to pay any additional contractors and subcontractors, and typically holds reserves for contingencies and internet.

What are Rates Like for Construction Loans

They usually trend a percentage point or so about current mortgage rates. There's a bit more risk involved since there's no existing house to use for collateral. Individual rates for these loans will depend on the construction plan, credit scores, appraisals, and other factors. In this way, these (custom loans) are very similar to mortgages, but construction loan rates are almost always variable, not fixed.

What are Terms like For Construction Loans?

They tend to be very short compared to traditional mortgages. Many last only a year or two while the construction process is ongoing.

Of course, owners aren't always able to pay the loan off after only a few years. That's why many construction loans are what's known as construction-to-permanent, which means after construction is finished the loan is turned into a traditional mortgage complete with a longer life and regular monthly payments.

Are There (Construction Loan Closing Costs)

Yes. Closing costs represent the total of the fees necessary to process and complete the loan. They are typically a couple of percentage points of the total loan or the expected value of the house, which usually means they are several thousand dollars. Closing costs are often bundled up with loan payments, and can sometimes be covered as part of a special discount.

What is a (Single Close Construction Loan)?

This is a loan that's designed from the very beginning to be a construction-to-permanent loan. That means there is only a single closing process, and the loan is automatically switched over after construction is complete. This has a couple of advantages: It helps save time, avoids the necessity of new appraisals or underwriting, makes it easier to lock in rates, and helps save on closing costs.

When is the Down Payment Due for a New Construction Home?

The down payment is generally due at closing. For construction loans, closing occurs when construction is complete and ownership of the home is officially transferred, also around the time that single close loans transition to mortgages.

Many construction loans include a builder deposit as well. This helps protect the builder if the owner decides to walk away from a project. If the builder deposit is not used by the time of closing, it is typically used to pay a portion of the down payment instead.

Do I Need to Go Through a Bank to Get a Construction Loan?

It's not necessary for the owners themselves to contact a lender. (Home builders with in house financing) can partner with lenders and take care of the details to make the process even more streamlined. This also makes it easier to pass through stages like builder reviews and architectural reviews, since the lender already has a standing relationship with the building.

This type of builder finance typically begins with a pre-approval loan application and credit check for interested owners.

Do Construction Loans Cover the Design Process?

Not usually. Design is typically a separate process with its own fees, or has already been taken care of by developers.

To learn more about the home design and construction process, visit our services at Lancia Homes. You can browse our floor plans, use our web tools to design a home of your own, or learn what open houses we have that you can visit. We can also arrange for a Zoom meeting so you can ask more specific questions about our process.