Getting a Construction Loan Vs A Mortgage Loan – Learn the Differences

Unless you plan to pay cash for your home construction project, you’ll need to take out construction financing and a mortgage for the remaining balance upon completion. Even though you may have qualified for a mortgage before, getting a construction loan for your home construction project can be a little tricky.

Although it is certainly possible to obtain a construction loan as a building owner, lenders may shy away from you at first, thinking that you are not qualified to handle such an undertaking. Thus, it is important to be very prepared and show yourself in an able and competent light when presenting your case to the lender. For example, don’t say, “I’ve never done this before, but I’m willing to give it a shot.” Instead, be positive, prepared, and professional. Never lie, but anticipate questions and concerns and be ready for answers.

There are several types of construction loans to choose from, but one of the most popular types of construction loans for people building their own home is a construction loan that turns into a permanent loan once the house is completed. Although there is no standard specification for this type of loan, as a guideline, most require you to pay closing costs only once. This saves some money and makes the process easier. You do not have to go through the qualification process twice. The downside is that it’s almost impossible to lock in a permanent mortgage rate, because you won’t be closing the loan for six months to one year.

No matter what type of construction loan you choose, you will likely be required to pay monthly interest on the construction loan amount during the construction phase. The amount you owe each month depends on how much you “drew” from the loan, not the total amount you are allowed to borrow. If you are approved for a construction loan of $100,000 but you only withdraw $50,000, your interest payments will be based on $50,000. Construction loans are usually standard (non-amortising) interest and are one or two percent over the principal rate, or whatever you negotiated with your lender.

Building qualification exceeds the income and credit qualification requirements of a standard mortgage loan. Bankers or lenders will want to know how you plan to handle your project and that you are able to build a home yourself. A comprehensive bank presentation would be in order. Here is an outline of what you will need to apply for a construction loan:

  • All the same financial information you would provide for a standard mortgage loan (financial statements, income check, credit report, etc.)
  • A collection of your plans (they may ask for several copies)
  • Detailed specifications (the materials and finishes you plan to use)
  • Cost estimate
  • Appraisal (ordered by the lending institution. The appraiser will use plans, specifications, and lot value to determine the amount)
  • Your lot information (whether you own it, etc.)
  • Contractor offers (not necessarily required, but may be if this is your first project)

You may also consider submitting any other documentation you can think of that will help determine your ability and willingness to complete your project. The bank essentially becomes a silent partner in your project and will worry about the house being built right. Demonstrating your ability to handle the project is key here.

Source by Bill Edwards, III

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