The purpose of a construction loan is to finance the building of a new residential real estate property. The projected market value of the subject property is used to secure the lending and the loan proceeds are distributed by the Lender via separate “draws”. Generally, once a certain phase of the construction works is finished, the Borrower is entitled for a “draw”. Installments are paid out periodically, after each stage of the project is found to be completed.
Therefore, prior to approving a given loan application, Lenders will request to see a detailed timetable and an estimated budget of the construction project signed by both: the applicant and the general contractor involved. It is very important that the Borrower keeps a detailed record of the paid expenses during each phase of the construction works or else the costs might not be reimbursed by the Lender. Organized bookkeeping should be in place to avoid delays of “draws” and all of the project’s expenses should be presented to the Lender. The payee list should include: date paid, name of supplier or sub-contractor, amount of payment, method of payment, payee address. The below items are some of the accepted expenses verification documents:
- Receipts for paid supplies and materials
- Receipts for paid labor costs – construction personnel wages
- Copy of cancelled checks
Also, before “refunding” the costs, the Lender will schedule inspections to verify the job is well done and that all of the listed materials were actually used in the construction works.
After the building is finished, the Borrower can apply for a traditional mortgage loan and repay the short-term obligation. If there are any unexpected delays with the project or additional expenses occur, the Borrower has the option to apply for a Bridge loan.
Qualifying and applying for a construction loan is not very easy, FICO shall be 680 or higher. If the Borrower chooses the discussed loan program, s/he will be rewarded in the following ways:
1 Reduced Costs: Building a house on your own can be cheaper than buying an existing property. Construction costs can be reduced with up to 40%, especially, if you already own a piece of land. The minimum loan amount is set at $75,000 and its maximum is $650,000.
2 Low Monthly Payments: Construction loan is an interest only borrowing thus the Borrower’s monthly payments will be low.
Additionally, interest is accumulated only on the distributed “draws”. It starts at 4.99% with a monthly increase of 0.5%, cap is set at 8.99%. The minimum down payment requested by Lenders is 20% and the value of the land (if owned) is used as equity.
3 No prepayment penalties applicable: Construction loan term is usually 12 months (possible 4 months extension upon request) but the obligation can be paid back at any time before its maturity date. The short- term nature of the loan eliminates the application of prepayment penalty and gives the Borrower flexibility.