What Is a Construction Loan?

What Is a Construction Loan?

A construction loan is more specific type of a loan designed for construction that has interests reserves, and the repayment ability is accomplished when the project is built. The loan enables a new home to be built through a duration of construction itself. Once you have secured your loan, the money lender will be paying the constructor after every period of the work completion.

How does mezzanine financing work in construction financing?

Mezzanine financing works in a away that the private companies, make an offer to investors to buy debt notes to their companies with the choice to convert those notes to equity stake.

There are different types of construction loan options. The first type is the construction only loans. The loaner gives the amount of money that will pay all the cost of the project. The borrower can make an interest payment on the loan until the project is done or for a specific period of time. This principle is commonly due when the project is done. This is a good choice of a loan if you have sufficient cash to pay it back or the sales from the current home will cover another construction project This allows the borrower to choose the best lender and apply for mortgage if he also needs to cover the costs.

Second type is the construction to permanent loan. In this loan type, the lender pays the builder when the project is complete. The costs are than converted to mortgage at the and This loan allows to shutting the interest rates at the closing, which makes stable payments. This loan is considered to be the best when you have specific construction timelines in place.

The third type is the renovation construction loan. This type of a loan is worn if you are purchasing a fixer upperin this occurrence, the government schemes are availed and the required cost of any renovations you intent on doing to the property is covered up in the mortgage, across with the purchase price.

Reasons to get a construction loan

  • To overcome damages and disaster expenses. If your offices or the apartments you are building get damaged by unexpected natural calamities like an earthquake, floods or even by fire, you can use the construction loans to settle the damages.
  • Hiring and training of employees. You can as well use the borrowed funds to higher the employees in the construction site. Also, use the funds to finance training and education fee to those employees.
  • Expanding your company facilities. If you are small business owner with a land that you need to build new offices or repairing the existing one, you can use the construction loan to finance your projects.
  • Purchase equipment and materials. You can use construction loans to buy materials to be used for the building of new home. All these finances for construction are acquired through proper research of lenders by the borrower.

reasons to get a construction loan

Benefits of a construction loans

The loans have low initial costs, and some do not require the initial costs at all This is very helpful on the financial side of things on borrowers. Some type of loans do not even request for the interest until the project is finished.They also have tolerant terms. Even if you’ll have to offer the bank with certain strategy plans you have for the project.The construction loans provides more tolerance in the terms of loans principles than traditional loans. Up to a given point, you will be in a position to solve your loan terms around your needs for the plan.

Moreover, you have full control of the project. These construction loans are made in way that you feel like you are putting your housing market in your hand. You can easily personalize everything in the process as you see fit, from scratch to up. And there’s nothing permanent here. You can install changes on the process if it is within your budget This actually assists to make sure that the project lies on the estimate and schedule. Besides, they are interests only during construction period, the loan is not paid out in full until the the building is complete. Hence during the construction period, the bank will require you to pay only the interests. Giving you much time to save.

Disadvantages of a construction loans

The shorter terms loans are risky. This happens when you are going for construction loan only When the loan term ends, you have to be in a position to pay off the whole loan. Therefore when you are using this type of loan make sure have a way to pay off the loan despite if your original finance falls along the way Also, the loans have higher interest rates. The construction loans have different types of interest rates that match to the prime or the rates that each bank gives its clients.

It appears to many banks that they have some added percentage apart from the prime rates they give. Which they rise the actual rates. Equally, many people find it difficult to qualify to acquire the loans. This happens due to the flexibility of the loans, thus they set high standards for one to qualify for the loans. In terms of down payments and credit.

Compare Construction Loan vs. Traditional Home Loan

The construction loan is one which requires you to build a house from the scratch on your plot of land, or purchase a potential home from the builders development. They are usually offered by local credit unions, also they have high interest rates compared to traditional loans, It has loan incremental disbursement. In this you must have specific building plan, construction contract and the entire building estimate to apply. While traditional loan on the other hand is one that you buy an already built house or newly constructed house. With low interest rates and lump sum disbursement of loan. Its application only requires you to have essential personal finance.

Construction financing

Construction financing is used for renovation purposes or also for building houses from the scratch. It is a specialized loan to customers who want to finish their construction processes. The finance is complicated because in the following ways; It involves so many parties in the process, this make it more challenging at times. Resulting to cases where one specialist my not understand the field of the other party. Bringing up to errors and complications. Secondly, is that large number of financial institution and the mortgage brokers are not familiar with the construction at all, resulting to challenges such as incorrect loan amount, and delay in loan disbursement as per changing requirements.

How can I get construction financing?

First, you have to shop around the financial institutions that offers best rates and terms on construction loans to potential home owners. Unlike other loans which are straight forward, construction loans are more complicated and requires you to fully understand repayment methods, to ensure that everything works according to your plans

Secondly get the financial institution to pre approve you, so that they asses how much loan you can pay for. You should be open with the lender and explain to him the purpose of your building This information will guide the officer to know if you will be able to raise the money with your financial option.

Thirdly, Discuss the loan interests rates with your loan officer. You have to ask if the interest rates will remain the same when the project is complete or is there any changes that may occur. Fourthly,hire a competitive contractor for the project since the lender will not approve the construction loan before he identifies the builder. After all this enter into a written contract with the builder, to identifies the responsibilities of each party as well as the amount he will receive on the project. Finally, with the assistance of architect design the house that is within the amount offered by the financial institution that you agreed earlier in the application.

The construction loan documents that I need

As other home loan you will be required to have documents like latest payslips, bank statements and other testimonials documents. Yet you will need more document to get construction finance. The documents include:

  • The building contract. This contains this like construction stages, the progress payment schedule, and the price to complete the house.
  • Extra quotes. This can be anything that is being installed be it solar panels for the pool and any extra landscaping. It is important to give the banks this information so that they can consider if this will improve the value of the property.

construction plan for a domestic home


The specifications of the building give the bank and appraiser, an idea on the set of finishes you require to use in the building and the standard of materials and appliance. This makes a big difference in the final quotation of the property. Lastly, building plans. Before your home loan is approved you don’t need the council approved business plan, instead they will give the appraiser the layout of the house you are constructing.

What does a standard HIA progress payment schedule involve

This involves payment of different amount at each stages of construction. The HIA system splits the payment, and they require the builders to follow the schedule since they require more payments at the beginning which is not the case. This is done to spread the risk in the whole process.

How Does a Bank Pay the Builder Directly

Bank pays the builder direct when they receive the invoice from the builder with complete draw down request form and sign on if When also the form and the invoice are directed to the construction sector in the bank. Finally, the bank has the validation that the work is complete, and also when the lender disburses money within a week. This process is repeated at each stage of construction.

How the payment mechanism works

lt works in way that the borrower pays is liable to pay interest on the draw down amount. Not on the whole amount held in the bank but that you have withdrawn only At the time of construction the person only pays the interest. This provide comfort by reducing burden during the tough period. You can convert the loan into; principle and interest, or you continue to maintain it as an interest only

How lenders assess risk on construction loans

Most lenders the features like capacity, credibility and the security of the borrowers before giving them loans.Clearly understanding the project and the amount it costs and uses their competent providers.

Collateral and Guarantees

In many construction, loans use facilities as collateral and when the fail to raise the money back they are taken away. Sometimes they may include land. Also they may require guarantees in which your investors agree to be personally liable in case you fail pay the loan.

Securing financing.

ln order for one to secure finance, you are required to be prepared in a way that you show your books. Start getting your documents earlier before your building project starts. Secondly, you have to build the right team. Lenders perceive less risks when the right team is involved. Your lender will tell about the project by your committee, so it is much easier to sell if he identifies that the members are professionals. And also puts the lender if he sees your investor group has high worth net. Thirdly you should line up tenants. The lined up tenants are easier to offer loans since they procure finance. Lenders on multi talent retail projects may require pre-leasing to more than one tenant before releasing finance.

If your looking for more information about construction loans then feel free to contact us.