The idea of building a home, sinking a swimming pool or pursuing significant structural adjustments to your property is all exciting, until you factor in the costs. Most people cannot afford the capital requirement for building a new home or major structural improvements.
Enter a special type of funding known as a construction loan. This refers to a short term loan advanced to individuals seeking to custom-build their homes or carry out other capital intensive property improvements. It differs from the conventional mortgage in the sense that it is short term, attracts higher interest rates as most lenders consider it risky and the amounts advanced can be used to fund not just the home but virtually every other property adjustments.
How does it work?
Construction loans are short-term, with their repayment periods extending to no more than 12 months. In most cases, this loan is offered to cover the cost of building your home or real estate project. Some lenders will fund you directly to pay the contractor in charge of the construction project and have the funds disbursed in bits throughout the different stages of the project.
To qualify for a construction loan, you must either have the backing of a qualified builder or be qualified developer yourself. You can also apply for an owner-builder construction loan, which is ideal if you are the one building your home. However, you will need to provide a “blue book,” which is a comprehensively researched construction list with all the costs, requirements, and projections.
Understand that the loan has to be repaid within the stipulated time. Most lenders have nonetheless, adopted these three flexible repayment options. Firstly, and the most popular involves repaying the loan in equal monthly instalments. Alternatively, you can choose to pay the loan monthly interest during the construction period and then pay bulk of the cash upon completion. You can also apply for the “End Loan” and use it to refinance the existing loan. This is a specialized part of loan refinancing where the next loan is converted into medium- to long-term fixed-rate mortgage.
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Why should you take a construction loan?
I. Capital for home investment
A construction loan gives you the money to invest in your home. Just like conventional mortgages, these loans are ideal if you are looking to become a homeowner, but have no capital to purchase your own house. The construction loan will cover all the costs of your project with the option of converting the loan into a mortgage later.
II. Build your customized home
Housing projects and initiatives can provide decent homes, but building your dream home to your specifications is at times more fun. A construction loan gives you the rare opportunity to build your house from the ground up. You can work with a builder of your choice or even make it yourself. These loans give you the freedom to design and build a unique home specific to the needs of your family.
III. Fund your commercial construction project
Construction loans can fund your commercial property and projects. If you are in the construction business, these loans can be used to invest in equipment, labor, or any other costs involved in the project. Since you have the option of refinancing, you can quickly own real estate property through long-term repayment plans.
IV. Relatively flexed repayment plans
You can find interest-only construction loans. Unlike other repayment options, interest-only contracts require you to pay interest on the initial loan, and not any part of the principle during the life of the construction. This does not only lower the total interest you pay on your construction loan but also makes repayment more feasible. Most construction loans are also refinanced into a long-term plan upon project completion, so you end up paying lower interest for the initial loan.
Pros
- Perfect credit for custom-homes and projects
- Covers all the project costs
- A short-term loan with feasible repayment plans
- Can be refinanced at the end of the term and converted to a long-term mortgage
- Allows you to save money on construction as opposed to mortgages
Cons
- Short repayment periods – often within 12 months or by the time of completing the project
- High and variable interests unlike the fixed rate mortgages
- Difficult to find especially if you are not a certified builder
Selection criteria
- Loan products and terms
- Loan application process and waiting time
- Minimum qualification requirements
- Customer service
- Interest rate
- Draw schedule
- Complaints and Reviews
Top 10 constructions loans for 2019
US Bank is one of the top picks if you are in the market for construction loans. The bank is well-versed in the new construction sector and boasts profound knowledge on how to successfully launch and complete projects. They quickly pair you with a loan officer to initiate the loan process. US Bank also offers several types of construction loans, including construction-only and building repair loans. They have comprehensive resources for construction as well as advice on how to get qualified contractors for your project. The bank also has substantial experience in the industry and is located in 41 states in the US.
Pros:
- Flexible construction loans and options
- Evenly distributed across the US
- Offers a loan officer for face-to-face support
- Varied loan offers
- Great customer care
Cons:
- No online application
- Lots of paperwork
Wells Fargo is another popular lender offering different types of construction loans for qualifying applicants. They have a nationwide network of consultants and loan officers who are available via phone. The lender also provides an extended rate lock program that locks your interest rate for up to 24 months. This significantly reduces the overall interest you end up paying on your loan. Wells Fargo also accepts online applications and has a financing checklist you can use to review eligibility requirements.
Pros:
- New construction loans
- Easy-to-reach consultants
- Home equity refinancing
- Online loan application
- Low down payment
Cons:
- Variable closing costs
- Requires high credit score (above 600)
- Unknown fees and APRs
Normandy is another mortgage lender offering various types of construction loans. They have a particular interest in funding residential home constructions. They also provide land loans and have expertise in the new home construction loans sector. Normandy has funded over $800 million in residential construction loans. They offer full services, including loan funding and servicing available in 39 states in the US. They also allow online registration and application. Successful applicants receive their loans within 21 days. Normandy enjoys a reputable A+ rating in BBB and offers online account management as well as online loan pre-qualification.
Pros:
- Quick loan application and approval
- Available in many states
- Multiple types of construction loans
- Offers land loans
Cons:
- High-interest rates
- Strict pre-qualification requirements
The National Bank of Kansas City is an FDIC insured bank and approved Freddie Mac and Fannie Mae Lender. They offer a wide range of home loan products, including VA, FHA, and building and construction loans. NBKC is highly reputed for exceptional customer service and convenience. They have 25 years of experience in the banking sector and allow nationwide online loan application. NBKC provides a line of credit home construction loan. They also offer discounts to members as well as a helpful finance calculator.
Pros:
- Simple application process
- Financial calculators and loan resources
- Wide range of home construction loans
- Nationwide online lending platform
- Low down payment
Cons:
- Mobile app limitations
- Limited office locations
Kabbage is another popular online lending platform that offers various types of personal and business loans, including construction loans. It provides a business line of credit loans to all qualifying companies. This includes all sizes and sectors. If you are looking for a construction loan awarded to contractors and builders, Kabbage offers a quick, convenient way to apply for up to $150,000. Repayments are made in six or twelve months with monthly fee inclusive of the interest. Unlike most lenders, you do not need an excellent credit score. However, you must have a business in operation for at least 12 months. This is ideal if you need construction loans for a real estate project or commercial buildings.
Pros:
- The convenient online loan application process
- Fast loan disbursement
- Low minimum requirements
- Flat fee rates and APRs
Cons:
- Must have at least 12 months business credit history
- Requires proof of monthly $4,200 minimum income
Quicken Loans is another popular lender with various construction and mortgage loan products. It is the largest online lender in the US if you are looking for an established lender with experience in both mortgage and home refinancing. Founded back in 1985, Quicken focuses on offering a wide variety of mortgage loans, both personal and commercial. Their current offers include VA, FHA, Adjustable-rate, Flat-rate, and Jumbo. You can also apply for a construction loan to finance your new house. Quicken offers loan and mortgage calculators, refinance guides, and various other resources in their extensive list.
Pros:
- Offers quick loans
- Accepts online application and approval
- Has various types of loans
- Ideal for refinancing
Cons:
- No home-equity refinancing
- No office locations
If you run a construction business, then you may need to take loans to fund projects awaiting invoices from your clients. FundBox offers invoice financing that allows you to borrow a maximum amount limited only by what your invoices generate. You can take loans from $1,000 to $100,000 paid within three to six months. It is more like selling your invoices at a discount. This loan can be used in construction or any other business. Loans are also disbursed within a few hours.
Pros:
- Smooth loan application process
- Minimum qualifications
- Perfect for funding various phases of your construction
- Low credit score limits
Cons:
- Higher annual interest rates
- Early repayment fees
Lending Tree suits businesses in the construction industry with its array of commercial construction loans. You can borrow term loans, SBA, lines of credit, and equipment financing loans, among others. The lending tree allows you to borrow enough capital to finance your construction projects. This loan aggregator offers a platform where you can find construction, mortgage, and home refinancing loans with adjustable and fixed-rate options. Their fees and rates are relatively low, although rates vary depending on the individual lender. You also need to have a business with an over 12-month history of operation and a minimum monthly income of $8,000.
Pros:
- Low rates and fees
- No need for credit score
- Quick loan disbursement
- Various types of loans
Cons:
- Variable interest rates
- High minimum monthly income requirement
Guaranteed rate is a highly reputed lender with various construction and mortgage loan offers. They offer a one-stop solution for that loans you enough capital to finance the construction and to purchase the property. Guaranteed rate is also ideal if you are looking for an interest-only construction and mortgage refinancing loans. As an interest-only lender, you will pay lower interest compared to other conventional offers. The platform is also reputed for customer service and is available in all the 50 states.
Pros:
- You can lock your interest during the construction phase
- Low down payment required
- Long-term home refinancing including 15 ad 30-year terms
- Smooth loan application process
Cons:
- Must have a FICO score of 700
- Draws outsides 12 months come at an extra fee
If you are looking for lenders offering traditional business loan, Funding Circle is among the top options you will come across. You can borrow from $25,000 up to $500,000 for whatever business purposes. This peer-to-peer marketplace suits small and medium businesses. Their main loan product is a termed loan with low-interest rates. You can borrow a loan for your construction project and pay within a period of 6 months to 5 years. However, interest rates vary depending on various factors such as credit score. They also charge origination fees.
Pros:
- Ideal for any business including construction
- You qualify for a higher loan amount
- Feasible predictable repayments
- Suitable for traditional creditworthy loans
Cons:
- Must have a credit score of 620 and above
- Origination fees and collateral
What to consider when choosing a construction loan
There are various things to consider before and after applying for a construction loan. These loans are not ideal for everyone, and there is no one-fit-for all. Some of the areas to give priority include:
I. Credit score
Qualifying for a construction loan can be tough if you have a limited credit history. You should, therefore, consider developing a consistent history and a good rating before applying for such loans. It is also essential to watch and continue building your credit after successfully applying for a construction loan. This will increase your likelihood of qualifying for the end loan, which is very critical in facilitating the refinancing of your credit into a long-term mortgage.
II. Loan terms and policies
Different lenders impose different conditions on their loan products. You should carefully read all the terms and clauses in the loaning agreement to ensure you are well informed on all aspects. You can also compare various local lenders in your area to find those with better loans and repayment terms. If you do not understand any part of the contract, ask the lender for clarity, or engage a professional attorney or real estate broker.
III. Builder vs. owner-builder
You can build your own home if you have the experience. However, most lenders are reluctant to fund individuals to develop their own homes. You will have to provide a comprehensive list of requirements and proof of knowledge/experience in construction. If you are using a builder, make sure you work with qualified professionals. This will ensure your home’s value is higher than the loan you took to facilitate its construction.
IV. Business vs. residential construction
Your project, including aspects of why you build the home, usually determines the best loan for you. If you are applying for a residential construction project, there are loan products better suited to residential apartments. Just as there are loans for building your own home. Loans offered to businesses that are in the construction sector are also different. Knowing these minor details will help you pick the best construction loan for your unique needs.
Bottom line
A construction loan can finance your dream home from scratch. It is ideal if you have the financial cushion to complete repayments within a year and deal with any construction set-backs. Upon completion, you can apply for an end loan and enroll for a current long-term mortgage plan. It is worth noting that construction loans are balloon mortgages that require payments to be completed by the time your home is finished. They are perfect for those with a piece of property they want to develop. If you are looking for a place to stay, a traditional loan or mortgage might be the right solution for your goals. Nevertheless, several lenders are offering feasible construction loans in the market. The above list comprises some top lenders that will allow you to build a unique home with your specifications.
FAQs
A construction loan is also referred to as a self-build loan and is taken by an individual wishing to build a home or any other customized real estate project. The loan can be used to either fund the entire project or just the initial stages of the construction project before the developer acquires long-term funding. Some of the unique characteristics of a construction loan include the fact that it is short term and is only availed to certified investors. Construction loans are a specialty of regional banks and credit unions as they have a better understanding of their local real estate market. To qualify for the loan, you must be a certified builder or prove that a qualified builder will oversee the project. You also must have a good credit score and raise the minimum down payment that ranges from 20% to as much as 30% of the cost of construction. Processing construction loan applications is a rigorous process that involves checking not just the financial background of the applicant but also their professional background as well as the viability of their construction project – the Blue Book. It may, therefore, take longer than mortgages – averaging between 7 and 10 days. Yes. For instance, if you a piece of land and wished to acquire a construction loan to develop it, most innovative lenders will agree to hold onto the land documents as collateral for the loan. This in some cases, eliminates the need for the down payment. The key differences between construction loans and a home mortgage lie in the amounts involved, the interest rates charged, and repayment periods. There is only so much that a banker is willing to advance you in the form of a construction loan while mortgages carry extensive loan limits. Additionally, construction loans carry high and variable interest rates while most mortgages are fixed rate. Construction loans must also be paid within a short period – usually 12 months – while mortgages repayments can extend to as much as 30 years. Like most other real estate related debts, construction loans carry significant closing that is paid during loan application and approval. The second phase of closing fees for a construction home comes about if you wish to refinance the loan and convert it into a mortgage where you get to pay the closing fees associated with acquiring the refinancing loan. While qualifying for a construction loan may be hard, it isn’t impossible. Before going through with the construction process, however, you must go through your lender’s qualification requirements to ensure that you fulfill their minimum requirements.