WRITTEN BY DAVID REED
A construction loan is one where funds are issued to build a new home. Some construction loans provide financing to build on someone’s lot they already own while some construction loans provide funds for both the lot and the construction. Construction includes funds for both soft and hard costs. Soft costs are those for things such as permits, zoning and legal compliance while hard costs are for materials and labor, for example.
When someone builds a new home, they’ll work with an architect to design the home. Sometimes they can also pick from a builder’s list of plans and choose a set of blueprints previously completed. The next step is to get a bid from a contractor who will break down the cost to build the home and how long it will take to complete the project. Next, the plans are delivered to the bank who will review the project and if it complies with the bank’s construction guidelines, the loan is approved.
But the construction loan isn’t issued in one lump sum. Instead, funds are issued in stages of completion as the home is being built. The first issuance of funds might be to clear and prepare the lot. Once the bank is alerted the lot has been prepared, an inspector will arrive at the property and confirm its completion. Then, the next stage is funded and so on until the home is finally finished. The bank will order out one last inspection to confirm the property is ready for occupancy. Now, the bank wants its money back.
Construction loans are short term in nature, only long enough to finish the project. This is where a permanent loan comes into play. While the home is being built, the buyers also obtain approval from a mortgage company that will issue a traditional mortgage, paying off the construction loan completely. There are a few programs out there that combine both the construction and permanent financing with just one loan, referred to as a “one time close” loan or something similar.
You’ll want to talk to your mortgage loan officer about permanent financing and the construction process in general and get your various financing options. But with many, getting a construction loan first and then replacing it with a permanent loan is the less expensive path.