Construction Loan 101: The Three Types of Construction Loans
As a professional in the construction loan servicing industry, you know what the basic types of construction loans are. However, it may be difficult to explain to others. Keep reading for a handy, simple explanation of what the three types of construction loans are. Then contact ECL Software at 800-625-5972 if you would like help with fund control software.
The Main Difference Between Construction Loans and Other Loans
First, let us consider what a construction loan is. It is a shorter-term loan than your traditional mortgage and it has a generally much higher interest rate too. The construction loan is not based on fair market values of homes, or the condition of the home, as a traditional mortgage would be. Instead, it is based on the projected value of the completed home.
1. Construction-to-Permanent Loans
These are the top loan choice when there is a specific construction plan in and place and a timeline has been established. The process goes like this: The bank pays the builder as the work is done. At the end, the cost is converted to a mortgage during the closing process. In most cases, this type of construction-to-permanent loan allows the borrower to lock in an interest rate when they close the loan, which helps ensure consistent payment expectations.
2. Construction-Only Loans
This is a unique type of loan that requires the borrower to pay it off in full when construction on the property is complete. It is often chosen by borrowers who already have a lot of cash to work with, and who are very confident that selling one property is going to pay enough to cover the cost of building another.
In this case, if, after the building is completed, it turns out you need a mortgage, you will need to find it and be approved a second time. That is the main difference between this and the construction-to-permanent loan – the latter automatically converts to a mortgage while the former does not.
3. Renovation Construction Loans
If you are buying a home that has seen better days and are planning to immediately fix it up, then a government program may be able to help. The cost of both the home and the mortgage can be wrapped up into a single mortgage. This makes it easier to get approved, as only one approval is needed, and it makes it easier to get the renovation completed.
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