Construction loans are short term, high-interest-rate loans. They are generally given for the construction of buildings, office spaces, shopping centres and residential houses.
What Are Construction Loans?
Construction loans are high-risk loans that are granted for a shorter period of one year, or a little more depending on reasonable construction plans, to the borrower for financing the real estate project or building a house.
Due to the high risk involved in them, they are termed at higher interest rates than permanent mortgage loans. These loans are taken to cover the fundings of the projects before getting the full term mortgage loans.
The lenders of the loan disburse the funds to the contractor or builder, not to the individual or owner of the project.
How Does A Construction Loan Work?
You wanted to start construction of your home or any other real estate project but could not have a good credit score or mortgage to get a loan from a bank or any designated financial institution, since the building is not ready yet. This is the traditional way of getting the funds and are called permanent mortgage loans.
Here construction loans come for the rescue, these are the hard money loans given by the lender before the construction of the project. Since high risk is involved there are various concerns involved in these loans.
The lender’s first and foremost concern is calculating the value of the property which is to be constructed once it gets completed. The lender does a thorough appraisal which targets to calculate the sale value of the property after its completion.
There are a number of factors involved in this appraisal which are; location of the property, the development plan of the project, contractor/builder credentials and work experience.
Here the credit history of the developer/builder also plays an important role as the amount of the construction loan is granted to him, not to the owner. These factors play an important role in deciding whether a borrower gets the construction loan and what will be the interest rate.
The borrower needs to provide the thorough plan (also called the blueprint) to the lender, which after satiating its nerves, the lender decides the loan terms and conditions.
How Are Construction Loans Disbursed?
Once the interest rates and other conditions are finalised by the lender, unlike the traditional loan where the whole amount is transferred in lump-sum, the lender pays to the builder in instalments for every phase of the construction like laying the foundation, framing etc.
Likewise, after the completion of every phase in the predicted time period, the lender does the inspection to verify if the funds are used pragmatically in the construction of the project. After having its satisfaction the next instalment is released for the next phase of the project.
Here the borrower did not pay the interest for the whole amount. The interest is paid only for the amount of funds released at every interval. At the end of the loan term, the borrower either converts its construction loan into a permanent mortgage loan or gets refinanced from another entity to pay off the construction loan.
Other Important Considerations For Construction Loans
Though the lender gets the construction loans without the mortgage but here also a downpayment of about 20% to 30% is required from the borrower’s end depending upon the lenders. In addition to this, the lender will also review the debt-to-income ratio of the borrower.
Furthermore, due to the lower credit history of the borrower, the lender demands the comprehensive plan of the project, construction material list, specifications, and a legally signed contract with the project completion timeline.
The contractor/ builder’s ability to complete the project in time plays a vital role, hence the selection of it should be of utmost priority.
Here at lendersa.ca, we provide you with the list of a number of hard money construction loans lenders where you can compare their program and get started with your project and that too without your social security number.