The housing and construction market got rocked by the pandemic. Low real estate sales inventory and buyer demand because of low interest rates sent property values through the roof.
Construction slowed because of worker shortages, supply chain issues, and soaring construction costs. The number of building permits issued fell by 3.2% in April.
There is a massive construction backlog, but what if you’re in a position to build a property now? You’ll need to get a construction loan to complete the deal.
Do you want to know how to obtain a construction loan? Read on to learn everything you need to know about getting one in this construction loan guide.
What Is a Construction Loan?
A construction loan is a type of loan that lets you finance the building of a real estate property or another type of project. This is a short-term loan that can cover the land purchase and construction-related costs.
You may be able to use the loan for planning the project, permits, engineering, and labor.
A construction loan is useful if you need contingency expenses. This is when the project goes over budget or gets delayed.
What are the normal terms of a construction loan? They’re only for 12-18 months. You have to pay the loan back in full within that timeframe.
You can use construction loans for fix and flip projects if you’re an investor. You’ll pay the loan back when you sell the property.
If you’re looking to build a property as your primary residence, you could convert the construction loan into a mortgage. This is called a construction-to-permanent loan.
If your lender doesn’t offer the ability to convert the loan to a permanent loan, you’ll have to obtain a mortgage that includes the cost of the construction loan.
There are other key differences between a mortgage loan and a construction loan. A mortgage loan gets secured by the property the loan is for.
Should you default on the mortgage, the bank takes the property and sells it to recover the costs.
Construction loans are unsecured. You could default before the project gets completed, so there are no guarantees for the bank.
Since they carry higher risks for lenders, they have much higher qualification standards and interest rates.
How to Obtain a Construction Loan
If you thought getting a mortgage is a strict process, wait until you apply for a construction loan.
Let’s take a look at what lenders usually look for to approve construction loans. They’ll start with your credit score. You’ll need at least a score of 680, though many lenders want a score of 720 or higher.
Lenders also look at what you have for a down payment. You’ll need a 20% down payment for a construction loan. The only way around that is to get a government-backed construction loan through the USDA or VA.
If you can get a government-backed construction loan, you may be able to get 100% financing on the deal or pay as little as 3.5%.
If you already have land, that could go towards the down payment.
Do you think you’ll qualify for a construction loan? Take the next step and find a builder.
The Builder, Lender, and You
The lender is keen on protecting its interest in the project, so they want to make sure you’re working with a reputable builder.
Lenders will want more than the name of the builder you’re working with. They’ll want to fully vet them. They want to know that the builder won’t run off with a lot of cash and not perform the work.
They’ll look at a builder’s payment history with vendors, licensing, insurance, credit rating, and finances.
There’s a lot of coordination that happens between lenders and builders. A construction loan gets dispersed in stages, rather than all at once.
The bank will set project benchmarks for the builder to meet. The lender sends inspectors to that site at each benchmark to review the project.
If the project meets the standards, then more money gets disbursed. You need to do your part to manage the project as well.
The lender wants to have every assurance that the project is viable and it will get completed on time before they approve the loan.
Know Your Requirements
You should have an idea as to what type of construction loan you need. Not every lender works with government-backed loans or construction-to-permanent loans.
You might need a fix-and-flip loan for your project.
Do you need to only fund construction or both the land and construction? If you need construction, then you can have the plans ready to present to the lender.
Shop for lenders
Are you ready to shop for lenders? Start by getting referrals from your network and researching construction loan lenders online. Your builder may be able to recommend lenders.
Check out the types of loans and services lenders offer. You want to have a lender who offers the type of loan you need.
The main thing you want to look for is experience. Ask lenders how many construction loans they’ve financed. For example, constructionspecloans.com closed more than 700 construction loans.
The more experience the company has with construction loans, the easier it will be to navigate any challenges that come up.
Construction loans carry a range of fees, just like mortgage loans. This varies between lenders, but you should expect to pay 1-2% of the loan amount in fees.
Compare fees and interest rates along with the customer service. You could end up paying a little more for the loan, but get a lot better service from the lender.
Construction Loan Tips
This construction loan guide showed you how to obtain a construction loan. Construction loans have higher standards to qualify, so the more documentation you can give to the lender, the better.
You’ll be able to get the best construction loan that meets your needs. Visit this site often for the latest market news.
Also published on Medium.
