How Does a Construction Loan Work?

construction loans

How Does a Construction Loan Work?

After years of dreaming, you’re ready to build your very own house, complete with all the designs and specifications you want. While you might be excited to finally have a space with a large master bathroom or spiral staircase, home development can be a long and complicated process. One of the first steps you’ll need to take is applying for a construction loan. Although it sounds intimidating, this loan will help you finance the home of your dreams. Find out more below!

What is a Construction Loan?

Before we delve into how this process works, let’s learn about the loan itself. A construction loan is simply a short-term, higher-interest loan that allows you to build or rehabilitate a home. The borrower will receive the money in stages as the project progresses. Unlike a traditional home loan, construction loans are based upon what your home’s projected value will be once the work is finished.

There are also three different types of construction loans:

  • Construction-to-Permanent Loans – This is the loan of choice when you have set construction plans and timelines in place. The bank will pay the borrower as work is accomplished, and the cost will be converted into a mortgage at closing, allowing you to lock in the interest rates and make predictable payments.
  • Construction-Only Loans – If you’re certain you’ll receive enough money from selling your current home or have ample funds on hand, this loan can work for you. You’ll need to pay it off in full once the project is finished.
  • Renovation Construction Loans – If you plan on buying a fixer-upper but don’t have cash for the updates, this type of loan could be just what you need! This loan is based on the home’s value after renovations.

How Do Construction Loans Work?

You may be familiar with traditional loans, which the mortgage company pays out to cover the cost of the home at closing in one lump sum. Construction loans, on the other hand, are paid out in installments called “draws” during the building process. These draws essentially reimburse the builder and help cover the cost for the materials they need. Teaming up with a skilled, reliable builder will make the process much easier, so do your research! As soon as the project is complete, the total cost will be transferred to the borrower.

How Do I Obtain a Construction Loan?

You’ll need a few things to help secure a construction loan, including:

  • Good to excellent credit
  • Stable income
  • Down payment
  • Timeline of construction, along with detailed plans and a realistic budget
  • Builder’s contract

Your lender will also more than likely review your employment history, savings, and ability to repay the loan.

Bank on Central Federal

Building a home can easily put a lot on your plate. Central Federal can help take the burden off your shoulders. Watch one of our happy customers, Trever, explain how we helped him get a construction loan! To learn more, please call us at (573) 364-1024 or pay us a visit at our location at 210 W. 10th Street in Rolla, MO!