If you are in the market for a new home, you may be considering a newly constructed home. In order to finance your new home purchase, you will likely need a construction loan. So, what exactly is a construction loan and how do they work? Keep reading to find out!
A construction loan is a short-term loan that is used to finance the cost of building a new home. Construction loans are typically used when a borrower wants to build a new home on their own land, or when they want to purchase a lot and then construct a home on that property.
Construction loans are different from other types of loans because they are not always fully funded at the time of closing. Instead, construction loans are typically paid out in installments as the construction project progresses. This allows borrowers to only pay interest on the loan amount that has been disbursed, rather than on the full loan amount.
In order to qualify for a construction loan, borrowers typically need good credit scores and a low debt-to-income ratio. Borrowers will also need to provide detailed plans and specifications for the proposed construction project, as well as an estimate of the total costs.
Once you have applied for and been approved for a construction loan, the lender will release funds to the builder at predetermined intervals. These payments are known as draws, and they typically coincide with specific phases of construction being completed (e.g., foundations being poured, framing is completed, etc.).
Once the home is completed and you have moved in, you will then need to refinance your construction loan into a traditional mortgage. This will give you one consolidated monthly payment instead of multiple payments (for the construction loan and separate mortgage).
Applying for and securing a construction loan can seem like a daunting task; however, understanding how they work can help make the process go much smoother. Now that you know more about construction loans, you can feel confident about financing your new home purchase!