Whether you’re building a new house or renovating an existing residence, a construction loan is a unique option to help borrowers create their dream home.
What is a construction loan?
A construction loan is a loan that covers the cost of building or renovating a home. The money may be used for all the costs related to the project, including buying land, permits, materials, labor, and other expenses. Keep in mind that the cost of designing your home or buying design plans is not included in the loan. This step of the process must be completed before loan approval.
How do construction loans work?
With a construction loan, you will build your home during the term of the loan. Typically, First Interstate offers six months for manufactured/modular homes, 12 months for custom homes, and 12-18 months for larger projects. It’s important to work with your builder on a realistic construction schedule.
Loan disbursements, also called draws, are paid to your builder as building progresses. Draws are paid on builder/client request. Working with a local inspector, your lender will confirm the amount of work done before releasing funds to the builder.
Steve Davidson, Regional Construction Manager for First Interstate, recommends borrowers look for a lender with an in-house draw process.
“The draw process is one of the most critical processes for clients and builders,” he said. “Making sure the lender has an in-house process makes the draws go so much smoother for everyone.”
During construction, you only make interest payments on the amount drawn. As your home nears completion, and the amount of money drawn increases, your monthly payments increase.
Once construction is complete, your loan converts to a permanent mortgage and your regular monthly payments, including principal and interest, begin. An escrow account for taxes and insurance can also be added to your monthly payment at this time.
Types of Construction Loans
The all-in-one loan combines the costs of construction and your permanent mortgage into a single loan. During construction, payments are interest only. When construction is done, the loan transitions into permanent financing with no need to requalify. This loan has one application and a single qualification process. You only pay closing costs once, and the interest rate is locked in at closing.
If rates improve before the loan transitions to a permanent mortgage, you can take advantage of the lower interest rates. This is called a float-down option, and it is free to the borrower.
A construction-only loan covers just that—construction only. Also called a two-time close, this loan covers the cost of land, permits and fees, and the building of your home. It is fully drawn when construction is complete. You’ll need to get a separate loan to refinance the construction loan into a mortgage. The new mortgage will have its own application, qualifications, terms, and closing costs.
A home renovation loan allows you to finance labor, materials, and other hard costs to improve your home. The loan amount is based on the estimated value of the home after your renovations. Whether you’re looking to remodel or finish your basement, a home renovation loan can help get your project underway.
What do borrowers need to get a construction loan?
For the most part, getting a construction loan is similar to qualifying for a traditional home loan. A borrower provides the same information required for pre-approval on a regular home purchase. You’ll also need the lot value and construction budget amount to get pre-approved.
Once you’re pre-approved, you can start designing your new home with a builder. The loan application process begins once you have final design plans and have agreed on a budget and contract with the builder. Your lender may want to review your builder’s work history and proof of insurance. A good construction lender will have familiarity and relationships with most local builders.
If you’re ready to build your dream home, contact a Construction Loan Officer to get started. We’ll help you every step of the way.