Home renovations and other construction projects cost a bundle, so a project manager may look into getting a building loan to start one. Here's how it works.

This Is How a Building Loan Works

It seems that the insanity that gripped the real estate market is finally easing up. Inventory increased and sales prices dropped by 6% in July.

That doesn’t mean that the market’s back to normal. In Austin, Texas, more than 50 homes sold $100,000 above the asking price.

For some buyers, it makes more sense to buy land and build a home on the property. The issue is that you need to get a building loan instead of a conventional loan to make this a reality.

Is getting a building loan hard? Is it possible to build or renovate a home after you buy it? What are the things to consider?

There’s no doubt that considering a building loan brings up a lot of questions.

Fortunately, you’re in the right place to learn all about building loans. Keep reading to learn how they work and how to get one.

What Is a Building Loan?

A building loan is also called a construction loan. They refer to the same thing.

You can buy a piece of land and finance the construction of a home on the property. You can also use the loan to renovate an as-is property.

In both of these situations, you can create the home you’ve always wanted. It beats trying to compete with dozens of other buyers who also want a house with the same features that you want.

You should know what a construction loan covers and doesn’t cover. This varies between lenders, but it generally covers the land purchase, architecture and design fees, materials, permits, labor, and contingency costs.

You want to be clear about what the lenders can cover with their construction loans as you start shopping for them.

How Does a Building Loan Work?

If you want to skip the craziness of the real estate market and create the home of your dreams, a construction loan might be a great option. How does construction loan work?

It’s a short-term loan, meaning that you have a short period of time to pay off the loan. A conventional loan may be for 15 or 30 years.

With a construction loan, the terms are for about 12 months.

Another way a construction loan differs from a mortgage is how they’re paid. With a mortgage, you get a lump sum that goes to the seller of a property.

With a construction loan, they get dispersed in stages. This is determined by the lender based on the plans for construction.

They usually disperse portions of the loan at certain benchmarks during the project.

For example, you could get a portion of the loan to start the project. Another portion gets disbursed when the foundation gets finished.

You’re responsible for paying interest on funds as they get disbursed. In other words, interest doesn’t accrue on the entire loan, only on the funds once you receive them.

Each payment has to get approved by an inspector or appraiser. They come to the job site, inspect the work, and then tell the bank it’s OK to make the next payment.

The payments go right to the contractor and you’ll find out shortly that they play an important part throughout the loan process.

What Happens at the End of a Building Loan?

With a mortgage, you pay the loan back in installments over the term of the loan. That’s what makes buying a home so affordable.

You can break down the cost of the loan over 15 or 30 years.

With a construction loan, you have 12 months or so to get the loan, finish your project, and pay back the loan.

The assumption is that you’ll sell the property and be able to pay back the loan.

If you plan to stay in the home and not sell it for a profit, you still have options to pay back the loan. You can convert your construction loan into a conventional mortgage.

That gives you more time to pay back the loan.

How to Get a Construction Loan

Getting a construction loan is a complex process because there are so many people and steps involved in the process.

The starting point needs to be your current financial situation. Take a look at your credit score and your credit report.

You’ll need to have a credit score of at least 700 for loans by private lenders.

There are government-backed loans like an FHA or VA constriction loan. You’ll need to have a credit score of 620 to get approved for these loans.

You shouldn’t have a large amount of debt relative to your income. Your debt-to-income ration needs to be around 40%.

The other thing you’ll need is a down payment. How much you need to put down depends on the lender, the project, and your credit score.

You can pay as little as 5% down or as much as 20%. It just depends on the factors mentioned.

Do you find a lender first or do you get a contractor first?

You should start by getting a construction contractor lined up. Be sure to find someone who’s licensed and has experience with building loans.

The reason why you need to have the builder first is that lenders want to see a contract before approving a loan.

You’ll also need to provide the cost to build a house and plans for construction. Then you’ll get preapproved for the loan.

At that time, you’ll be able to finalize the plans and submit the final documents for approval.

Getting a Building Loan for Your Next Residential Property

Are you ready to build the home of your dreams? Now that you know how a construction loan works, it’s a lot easier to figure out what your next steps are.

This guide showed you what a building loan is and how to get one. You’ll be able to navigate the building process with a bit more confidence and knowledge.

Do you want more helpful insights? Head over to the home page of the blog today!

Leave a Reply

Your email address will not be published.