Construction Loans
Payments & Disbursement
What is a Construction Loan?
A construction loan is a specialized short-term loan designed to fund the construction or renovation of a home or building. Here’s a breakdown of how it typically works:
Loan Approval and Disbursement:
- Loan Approval: The borrower applies for a construction loan, and upon approval, the lender provides a predetermined loan amount based on the projected cost of construction.
- Draw Schedule: A draw schedule is established, outlining specific milestones or phases of the construction process. Funds are disbursed in installments, or “draws,” at each completion stage.
Funds Disbursement to General Contractor:
- As the construction progresses, funds are released to the general contractor at key stages, such as foundation completion, framing, roofing, and so on.
- The borrower or builder typically requests a draw by providing evidence of completed work, such as invoices, receipts, and inspections.
Interest Accrual and Payments:
- Interest on the construction loan accrues only on the funds that have been disbursed. Borrowers are usually required to make interest-only payments during the construction phase.
- Payments are calculated based on the outstanding balance of the funds that have been drawn.
Conversion to Mortgage Loan:
- Once the construction is complete, the construction loan transitions into a permanent mortgage loan. This process is known as loan conversion.
- At this point, any interest that has accrued during the construction phase is typically added to the loan’s principal balance.
Mortgage Repayment:
- The borrower begins making regular mortgage payments, which now include the principal amount, accrued interest from the construction period, and property taxes and insurance.
- The mortgage may have a fixed or variable interest rate, depending on the terms agreed upon with the lender.
Mortgage
Construction Loan
15, 20, or 30 years
1 year or less
Minimum Credit Score: 620
Debt-to-Income Ratio: 43%
Minimum Credit Score: 680-720
Debt-to-Income Ratio: 45%
3.5%–20%
20%–30%
Lump Sum payment
Incremental payments
Interest + Principal + Tax + Insurance
During Construction: Interest
After Construction: Mortgage
Mortgage VS. Construction Loans
Understanding Construction Loans
Construction loans differ from mortgages in a few key aspects. Unlike mortgages, a construction loan involves a short-term financial agreement by a lender to cover the expenses of home construction and often the land acquisition costs as well. It is common to contribute a portion of the funds, typically around 10%-20%, as equity. The interest rates for construction loans are generally variable and adjust with the prime rate.
One-Time Close Option
Some lenders offer a “construction-to-permanent” loan or a “one-time close” option. These loans can help you avoid duplicate closing costs, but there are downsides. For example, cost overruns during construction can be challenging for everyone involved. Additionally, a one-time close may require more equity and a strong credit score to offset higher risks.
Necessary Documents
To get a loan, you need various documents: recent tax returns, employment records, credit balances, bank statements. For a construction loan, you’ll also need builder contract, architectural plans, budget, track record, and construction schedule. The bank must approve the builder; financial info from them may be required. Bank may contact builder’s suppliers for payment status.
Avoid Delays & Surprises
To expedite the loan approval and closing process (which can take up to 45 days), it’s crucial to respond promptly to requests from the lender or title agent. Review closing documents upon receipt and address any concerns beforehand. Avoid waiting until the closing table to read the fine print.
Paying Your Builder
Builder payments are made as construction advances under the loan. A draw request is submitted by the builder after each completed stage of work for payment. Both the property owner and builder must sign each draw request. A third-party inspector verifies progress before funds are released, ensuring fair payment. This process protects lender, owner, and builder. Subcontractors are paid on time, keeping them happy and engaged. (200 characters)
Convert to a Mortgage
Around 45 days before home completion, reach out to your mortgage lender whom you worked with earlier. They will check your credit, order the final appraisal and survey, and may ask for current bank statements to ensure enough funds for closing. To avoid mortgage loan complications, don’t make changes to your credit or employment during construction. Examples include getting a new car loan, making major credit card charges for home furnishings, or switching from a long-held job to self-employment.
Find a Construction Loan Specialist in Tucson, AZ
Chris Wilkes
Residential Mortgage Lender | NMLS ID: 818937