Everything you should know about construction loans

Some people prefer to buy a home while others would like to build their home from scratch for one reason or the other. Either way, you will need a lot of financial support in order to get any of the deals done. The main difference is, you will not get a mortgage for complete home construction but instead, you can apply for a construction loan. One alternative to construction loans is personal, unsecured loans, they are unsecured loans which you can borrow for up to 6 years. Although the amounts that they offer are much less than construction loans themselves, they are great for aspects like home improvements and DIY. 

What is a construction loan?

They are short-term loans with high-interest rates that are mostly used to cover any cost of the home improvements, reconstruction and building a home. While traditional home loans are solely based on the market value of the property and highly determined by the condition of the house depending on recent sales on similar homes, the construction loans will be determined by the value of the project and the future price of the home when the construction is complete. 

Three types of construction loans

The construction to permanent loans

unsecured loans - building house

They are perfect for individuals who have a definite plan for construction with the timeline of construction laid out clearly in the plan. The lender or investor will make the loan dispersal or payment as the construction work is being done. The finances are then converted to a mortgage plan after closing. This type of loan will allow you to get locked interest rates which makes the repayment steady and easy.

The construction only loans

These types of loans should be fully paid off as soon as the construction is complete.  This is the best choice when you have enough money for this kind of work. Especially if you are sure that the money you get from the sale of that house can cover another building. For the mortgage, you will need to search for the lender, apply and wait for the approval.

This is how construction loans work

Conventional loans are given out to individuals by mortgage and loans companies to cover constructions costs. They are given out in one lump sum. The construction loans are given out for the same purpose but they are offered to you in instalments. The bank or mortgage lender pays the builder during different stages during the whole process. The cost will be transferred to you when the construction is completed.

The construction loan instalments are referred to as draws. Each draw given at a specific stage is meant to cater for the cost of the builder. This is so they can buy materials and build at that specific stage. The lender, bank or mortgage brokers make sure they have a professional do an inspection on the cost of the specific stage of building to ensure you are giving them the right estimates.

Some benefits of construction loans

Choosing this loan over other types of loans for construction has some major benefits. For one, the payment is interest only when the construction is still ongoing. The principle amount is not paid in full until all the construction is complete. The terms of the loan are flexible when compared to traditional loans alike mortgages. Finally, the scrutiny ensures that the process stays on time and budget.

Unsecured loans

Personal, unsecured loans are loans which aren’t attached to any collateral. This means that if you have any late repayments, you won’t have something taken away from you. For example, if you had a secured loan and couldn’t keep up with the payments, you would have whatever the asset was taken away, whether it is a house or car. But, with an unsecured loan, if you are unable to repay your credit score will be impacted negatively. This will be a red flag for future potential lenders. There are multiple other things which unsecured loan lenders can do including taking legal action, but this isn’t a regular occurrence.


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