by Tara Mastroeni
September 10, 2018
by Tara Mastroeni
September 10, 2018
Shutterstock
If you’ve chosen to build your dream home rather than buy an existing one, it may surprise you to learn that you won’t be getting a traditional mortgage. Instead, you’ll likely get a construction loan. For your benefit, I’ve put together a primer on construction loans. Keep reading to learn what these loans are, how they work, as well as some of the pros and cons of using one to finance your home.
What are construction loans?
Construction loans are higher-interest, shorter-term loans that are used to cover the cost of building or rehabilitating your home. Unlike a traditional home loan, which is based on the fair market value of the home and determined by the home’s condition in comparison to other recent sales, construction loans are based on what the projected value of the home will be once the work is complete.
There are three different types of construction loans that you can choose from:
How construction loans work
Traditional loans are paid out by a mortgage company to cover the cost of the home in one lump-sum at closing. In contrast, construction loans are paid out in installments. A bank will pay the builder as various phases of the building process are completed. The total cost is transferred to you once the entire project is finished.
These installments are called “draws.” Each draw reimburses the builder for the costs needed to cover that phase of building, meaning that they—or you—have to have enough cash on hand to cover these costs upfront. Before each draw can be made, the bank will do an inspection to verify the estimated cost of the current phase of building, as well as how well the builder is moving on their projected timeline.
Since the financing of a construction loan is so variable, it’s crucial to work with a good builder. You need someone who’s experienced with budgeting and scheduling and who also has the ability to work well within those limitations. Make sure you do your research before applying for a loan, so you end up with someone reputable.
What are the benefits of a construction loan?
Choosing a construction loan over a home equity line of credit or other privatized loan has a few, distinct benefits. They are:
What are the disadvantages of a construction loan?
Like anything, there are also some disadvantages to construction loans. They are:
This article was written by Tara Mastroeni from Forbes and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.