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A construction loan is kind of like a complex novel, and a lender has to know the outcome before they’re willing to give you the money. For this reason, a construction loan cannot be underwritten by typical Freddie Mac or Fannie Mae guidelines. Because of the differences, construction loans fall into a few common features that many loans must conform to. For instance, your construction loan might require an interest only payment during your construction period, and then become due immediately upon completion. FYI: official completion for a homeowner means that you have acquired a certificate of occupancy.
Additionally, a construction loan will typically be a variable rate, or adjustable rate loan (ARM), and priced according to the “prime rate” or some other short term interest rate. The contractor, lender and yourself establish a schedule on which you will draw the money from your loan to complete certain phases of your construction. Payments are based on the interest charged on the amount of money that you’ve had disbursed currently.
One further difference in construction lending in contrast to a traditional, conventional loan is the Loan to Value (LTV), or the percentage of the future value of the project in comparison to the amount of the loan. A lending institution is usually not willing to lend as high of an LTV for a construction loan as they would for a typical purchase or refinance. FYI: IF you already own the land, it will actually be considered equity in your future value.
The most common type of construction loan in a “construction-to-permanent” finance option. In this type of loan, the construction loan will automatically be converted into a mortgage loan when the certificate of occupancy is acquired. The advantage of this type of loan is that there is only one application and closing process to make the whole experience as streamlined as possible.
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