If you’re in need of financial help to build or renovate your dream home, then construction loans are the answer to your prayers. However, it is essential to note that such mortgage is different from your traditional home loans.

If you’ve made up your mind to build your home rather than buying a prebuilt home, then you must know that construction loans work differently from a traditional mortgage. Here is what you need to know about Construction Loans.

Defining Construction Loans

Construction Loans are short-term loans borrowers can use to cover the cost of your home’s building or rehabilitation. When approved, all you need to pay while your house is being constructed is the interest of the loan, meaning you have ample time to save for the amount you need to pay for the loan. Once construction is complete, you can either pay in full or convert the loan into permanent mortgages.

Construction Loan Coverage

The coverage will depend on your project, but it usually covers for the following:

  • Closing costs
  • Contingency reserves
  • Fees
  • Interest reserves
  • Labor
  • Land
  • Materials
  • Permits
  • Plans

The Three Basic Types of Construction Loans

Usually, lenders only offer to construction loan types – the Construction-to-Permanent Loan and the Stand-Alone Construction. However, there are those who also provide Renovation Construction Loans.

Construction-to-Permanent Loans

Also known as One-Time-Close Construction Loans, these are an excellent choice for people who already have a definite timeline and straightforward construction plans at hand. You can enjoy predictable interest rates, and it can convert to a permanent mortgage after your project is complete.

Stand-Alone Construction Loans

These will require you to get qualified and approved for the loan. One needs to pay the mortgage once the construction is complete, and may require you to pay closing costs multiple times. The interest rate is unpredictable, meaning if it increases while your home is under construction, you can expect higher interest rates after completion. This is for individuals with large cash reserves.

Renovation Construction Loans

These are the type of construction loans that allow borrowers to fund major renovations and repairs. Thus, the renovation construction loan is perfect for people buying a fixer-upper. The costs are wrapped in the mortgage together with the purchase price.

Good Read: Loan options abound for remodeling projects

Advantages and Disadvantages Of A Construction Loan

  • You will only pay the interest of the loan until construction is complete. Your lender won’t ask you to start paying for the principal amount during the construction phase. You’re only expected to pay the interest thus giving you more time to save.
  • They usually come with higher qualification standards. Since construction loans are flexible, they are often harder to qualify for. Most lenders will ask for 20% down payment along with a good credit score.
  • Such loans have very flexible terms. The terms are so versatile to the point wherein you can make the conditions work around your needs and situation.
  • Since such loans are short-term mortgages, they come with risks. Like any loan, there’s a risk of you not being able to pay for the construction loan. So, make sure to check your finances before applying for a construction loan to ensure you can pay off the mortgage.
  • It adds scrutiny on your home project. Construction loans can ensure you stay within your budget and that you meet the timeline indicated.