Getting the right construction loan can be one of the biggest decisions for your home building and remodeling business. But if you’re new to home construction, it can be confusing to understand how construction loans work. Let’s break down the basics of construction loans so that you can understand what to expect when applying for one and how to use them for your construction business.
Construction loans consist of short-term loans that have adjustable interest rates. They can be repaid once property or projects are completed.
Construction loans can be used for projects like financing new builds and helping with renovations or demolitions. In general, construction loans are issued for a year and have higher interest rates than traditional loans.
The main difference between traditional mortgage loans and construction loans is what is covered for the length of the loan.
Construction loans are split into two types:
Overall, traditional mortgage loans are fixed rate loans that have a specific interest rate and term. These can be conditional, which require a higher credit score and down payment, but also have lower interest rates.
Protip: Download our free construction calculator collection which includes a simple-to-use construction loan calculator that you can use to discover how much a loan will cost on your next project.
In order to qualify for a construction loan, you’ll want to make sure you have the right documentation for your project including detailed estimates from contractors showcasing your financial ability to complete the project with the loan.
In addition, it’s helpful to note how much money you’ll need for your construction project, contractor bids, and overall plans.
Make concrete plans on how you’ll pay it back in the long term before you apply.
When you apply for a construction loan, you will need to put down a percentage of the total cost of the project. The amount that you’ll need to put down will vary depending on the lender, but it’s typically around 20%.
Your project worth should be known upfront so the lender can determine how much they will lend. An appraiser can be used to help the lender come up with an estimate.
You should have specific plans and specs for your project to determine if it’s something they want to finance. This is especially true if you’re planning a major renovation since they’ll want to make sure the finished project is up to standards.
If a contractor is involved, the lender will want to see a contract. This is to make sure someone is responsible for completing the work and that the work meets all requirements.
Your lender needs your proof of income to see if you're able to repay the loan. This can be in the form of tax returns, bank statements, or pay stubs.
When using a construction loan, you’re able to finance the building process from start to finish. When you secure a construction loan before building, you’ll have more flexibility to make changes and the potential to save money over time.
If you decide you want to make changes during construction such as adding additional space or changing locations of the build, construction loans can help with this. Traditional mortgage loans don’t allow for as much flexibility since they aren’t specifically for construction.
In addition, with a construction loan, you can design a more energy efficient house that could save you money on utility bills and insulation. With options like low maintenance materials for your floors and walls, you can save money on repairs and maintenance overtime.
To apply for a construction loan, you’ll want to follow these steps to make sure you get the best rates and best lenders for your project.
Look at different lenders and compare rates, terms, and fees to find the best option for your project. Don’t be shy about checking multiple websites; look for the best fit for your project based on scope and need.
Have a clear understanding of how much you’ll need before you apply. This will help you know how much you need to borrow, what terms you’re looking for, and how long it will take you to pay off the length of the loan.
Make sure you have all of your financial documents and cosigner before you apply. Have your tax returns, bank statements, and proof of income handy. And if your credit score isn’t high enough, you’ll need a cosigner who agrees to sign the loan with you and who is responsible for making payments if you default on the loan.
When you apply, you’ll also need to submit supporting documents like blueprints, plans for your project, or estimates from contractors. After the paperwork is signed at the closing, your funds will be distributed.
Construction loans are a great way to finance your new home build, but it doesn’t stop there. You’ll need software to help you manage your construction projects and create proposals that keep clients coming back. Run your construction business more efficiently and manage your business with BuildBook.
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