How Construction Loans Work

Construction loans are story loans. That means that the lender has to know the story behind the planned construction before they’re willing to loan you money. Because it’s a story loan, it’s not going to be standardized like mortgage loans underwritten to Freddie Mac or Fannie Mae guidelines. That said, there are some common features to a construction loan. Construction loans typically require interest-only payments during construction and become due upon completion. Completion for homeowners means that the house has its certificate of occupancy.

Construction loans are usually variable-rate loans priced at a spread to the prime rate or some other short-term interest rate. You, the contractor and the lender establish a draw schedule based on stages of construction, and interest is charged on the amount of money disbursed to date.

Another variable in construction loans is how much of the project cost the lender is willing to lend. If you already own the land, then that can be considered as equity on the construction loan.

A construction loan, unlike a mortgage, isn’t meant to be around for a long time. If you’re taking out a $200,000 construction loan for six months and you pay an extra 0.5 percent on the loan, it costs you an additional $250. (Assumes an average $100,000 loan balance over a six-month construction period.)

You may need to be willing to pay a higher rate on the construction loan if you’re doing construction-to-permanent financing and can get better mortgage terms or a longer, better rate lock from that lender.

Construction To Permanent Financing

Building a new home but worried about the complicated financing of two separate loans? You need Construction-to-Permanent financing (also known as a C-Perm or CTP). A Construction-to-Permanent loan can be used for new construction or additions to an existing property.

Construction-to-Permanent Loans Offer:

• Simplicity – One application, one approval process and one set of closing costs.

• Convenience – You can buy the land, close your construction loan and secure permanent financing all in one day! And when the construction is complete you have an option to decrease your loan amount.

• Rate lock options – You can lock in the mortgage interest rate during the construction period for up to one year, with the opportunity to secure a lower rate if rates decline.

• Flexibility – Available in fixed-rate, adjustable-rate, balloon, and jumbo mortgage options.

Applying For A Construction Loan

When you’ve decided you’re ready to apply for a construction loan, it is important to work with a mortgage provider who is dedicated to keeping you informed and on the right track every step of the way. The loan application process has two primary stages: completing a loan application and providing your lender with copies of all required documentation.

Completing a loan application can be done using our convenient and secure online form, or you can talk with one of our experienced mortgage specialists to provide your information over the phone, in person or by mail.

Gathering copies of your personal financial documents in one file will help make the process of securing a new loan more convenient and efficient. Your lender will require in-depth information about your financial background to proceed to the loan processing stage.

Determine what items you’ll need for your mortgage application. It is important to note that you and your spouse need to provide full financial background information, as do any co-borrowers.

Items Needed For Construction Loan

1. Builder Resume + completed application

2. Articles of Incorporation/Partnership Agreement

3. Personal Tax Returns for the last 2 yrs.

4. Personal Balance Sheet (signed & dated)

5. Corporate/Partnership Tax Returns for the last 2 yrs.

6. Current business balance sheet & signed Profit & Loss statement

7. Lists of subs and suppliers

8. Copy of builder’s license

9. Evidence of liability insurance

10. Most recent bank statements (personal & business)

11. Construction Loan Inventory

Loan Processing and Underwriting

Loan processing and underwriting is a team effort, and we will keep you up to date during every step of the process. Following is an overview of what to expect during the construction loan process.

Once your loan application has been completed, your loan officer will work with a dedicated loan processor who organizes all of the paperwork into one file. Your loan processor will make sure that the required documentation is in good order. If there are any missing documents, or any other information needs to be verified, your loan processor will contact you so everything can proceed smoothly.

You decide when to lock in your interest rate. This “rate lock” is an interest rate guarantee the lender makes to you for an agreed-upon time in order to protect you against interest rate fluctuations.

A real estate appraisal will be ordered when the home or property will be used as collateral for a loan. This professional written analysis of the fair market value of the home or property provides an estimate of the likely price the asset would bring if sold in a competitive real estate market.

A home inspection is recommended to evaluate the general quality of the home such as its structural condition and remaining life of major components, including the roof, plumbing, heating and electrical wiring.

A title report is ordered. This important review of the property deed and other government records is done by a professional title company to determine whether the owner has a legitimate interest in the property. It also summarizes whether any restrictions or allowances pertain to the use of the land, outlines the status of property taxes and other public or private assessments, and identifies whether any judgments or liens exist on the property that must be satisfied.

Underwriting is initiated when the loan processor has verified that all paperwork has been completed. The team’s underwriter checks to make sure that the facts in the applicant’s loan file correspond with the guidelines of the loan being offered. The underwriter also reviews details such as income, credit score and the appraised value of the home or property. If any information is missing, the underwriter may conditionally approve the loan with the stipulation that the information must be obtained and approved before the loan can be funded.

The loan processor resumes oversight of the loan file to track the receipt and condition of any pending documents, and works with the title company to get all of the paperwork in order for the loan settlement.

Certain types of insurance will be required. Title insurance is needed to protect the lender’s financial interest in the property if there are defects in property title, liens or other matters. Homeowners insurance is necessary to cover physical damage to the property. Depending on the home’s location, the borrower may also need to secure flood and/or earthquake insurance. If the down payment is less than 20% of the purchase price or appraised value, private mortgage insurance (PMI) may be required.