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Construction Loans: Everything You Need to Know

Building the home of your dreams isn’t easy.

You work hard, save your money and explore your area until you’ve found the perfect neighborhood. You figure out where you want your home to be and what you want it to look like inside and out. But how do you actually go about building your dream home?

A construction loan can help you pay for the cost of building a new home or gutting and refurbishing an existing one. It works a little bit differently than most personal loans because construction loans are designed to fit a very specific set of circumstances. Typically, home construction loans are short-term loans.

If you’re not sure what a construction loan is or how it works, read on. We’ve put together a guide with everything you need to know about the construction loan process so that you can decide whether construction loans are right for you.

What Is a Construction Loan?

A construction loan is a short-term loan, which covers the cost of home construction projects. Construction loans can be used to cover the cost of buying land, hiring a contractor, and purchasing building materials. You can also use your construction loan to pay for all the plans, permits and fees associated with building a home as well as your closing costs.

Many people also build a cushion known as a contingency reserve into their construction loans, borrowing slightly more than they need for their building project just in case the project ends up costing more than expected. Construction loans can be used to pay for just about every cost associated with constructing your home.

How Are Construction Loans Different from Mortgages?

Construction loans are different from other home loans in a few important ways. Term length, rates, how involved your lender will be in the process, and how you go about paying the loan back are not quite the same as with all mortgage loans.

Term length

Typically, a construction loan has a fixed term of about one year — the length of time most new home construction is expected to take. After the completion of the construction of your new home, your construction loan is then refinanced and converted into a conventional mortgage.

Lender Involvement

Construction loans are more tightly structured than other loans, and they involve a lot more lender interaction. When you take out a construction loan, in most cases, your lender will actually be paying money directly to your contractor, not to you. The lender pays the contractor in installments, also known as “draws,” which are issued whenever the contractor completes one stage of the project.

Your lender will carry out regular inspections to see how work is proceeding and to determine whether your contractor has earned the next installment. You’ll work with your lender before construction begins to set up a schedule for inspections and payments.

Repayment

You make interest only payments on your construction loan until the work on your new home is complete. When construction is finished, you can refinance and convert your mortgage into a conventional mortgage.

How to Get a Construction Loan

Most construction loans are designed to pay for the plot of land that your house is built on as well as the construction itself. This means you’ll usually apply for a construction loan at the very beginning of your home-building process. You should meet with your lender once you’ve found land and chosen a contractor to build your home.

When you apply for the loan, your lender will ask to see detailed plans for your future home. They’ll want to see your building schedule, and they’ll want at least a rough budget for materials and labor so they can estimate how much the total construction process will cost.

Be aware that lenders want to see a well-thought-out and highly detailed plan. They want to know that you’ve thought this project through and are committed to completing it.

Your lender will ask questions about the contractor you’ll be working with. After all, the lender will have to work with your contractor, too. They’ll be carrying out regular inspections of your contractor’s work and issuing payments after each stage of the project your contractor completes.

Your lender will look at your credit score and your debt-to-income ratio before approving you for the loan.Most lenders will expect to see a credit score of at least 660 in order to agree to a construction loan. They’ll also want to see a debt-to-income ratio of less than 40% and a maximum loan-to-value ratio of 90%.

Some lenders require a bigger down payment than they might on a traditional home loan. Most of the time, lenders will ask for a down payment of 20 to 30% of the total cost of your building project. However, that’s not always the case. At Field & Main, we ask for a minimum down payment of just 10% of the cost of your building project.

What Are the Different Kinds of Construction Loans?

There are a few different kinds of construction loans out there. Each one is designed to meet a different set of needs and a different set of circumstances. Take the time to learn how these loans work so that you can figure out which option is right for you.

Construction-Only Loan

As the name suggests, construction-only loans pay for the construction of your new home or for the renovation of your existing home..

These loans usually mature after about a year or less. Once the term is complete and your home is built, you will meet with your lender to begin conversion of your construction loan to permanent financing.

You will have to apply separately for a permanent financing..

Renovation Loan

Loans for simply remodeling your home are also known as renovation loans. Renovation loans are designed to help you carry out home improvements rather than help you build a new home from the ground up. Different types of loans can work as renovation loans depending on how costly your home improvement project is going to be.

If your renovation is relatively low-cost — in other words, if you’re going to be spending less than about $20,000 — it might make sense to pay for it with a home equity loan or a home equity line of credit (HELOC). Refacing your cabinets, building a new deck or even repairing your roof all fit into the category of home repair jobs that you might be able to pay for with a home equity loan or a home equity line of credit. .

Home equity line of credits tend to come with relatively low interest rates, which makes them an attractive option. If you’re fully renovating your bathrooms, your kitchen, or your basement, then a HELOC might work for you as long as you’ve got enough equity in your home.

Some homeowners opt to use a cash-out refinance loan to pay for expensive repairs or home improvement projects. You can use the surplus to pay for home renovations — or anything else you’d like. This can be a great way to get to the home improvement projects that you’ve been looking forward to while also lowering your monthly mortgage payments.

Owner-Builder Construction Loan

An owner-builder construction loan is a specialized form of construction loan used when the borrower is also the contractor. If you are a licensed, working contractor planning on building your home (or carrying out extensive renovations) on your own, this kind of loan might make sense for you.

Final Thoughts

The process of constructing your dream home is going to look different for everyone. For some people, it will mean buying land and constructing a house from the ground up. For other people, it might mean gutting an existing structure and rebuilding it to meet a set of specifications.

No matter what the specifics of your situation may be, a construction loan with the right lender can make your dream come true by giving you the funds you need to build your home. And with the right planning, you can make that construction loan transition to a mortgage so you can fund your home-buying enterprise all the way through.

You will need to have a clear and detailed plan for how to build the home you want. You will need to find a highly skilled and reliable contractor who’s willing to work with both you and your lender throughout the course of your project. You’ll also need to find a lender you’re comfortable partnering with.

Choose a Lender You Can Trust

At Field & Main, we pride ourselves on building great relationships with all of our clients. Our staff believes in putting people first, and we’ll always go out of our way to be accessible.

If you’d like to learn more about the construction loans offered by Field & Main, give us a call today. We are a community-based lender that has worked with numerous families in your area to help them create their dream homes. Our friendly, knowledgeable staff is waiting to talk with you about your plans for building your dream home.

Give us a call at (888) 831-1500, email us at service@fieldandmain.com, or “chat” us in our mobile app or online banking.