Benefits and Risks of Construction Loans

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( — April 28, 2019) — Construction home loans offer flexibility in how the homeowner can use the funds. Instead of getting a mortgage with long-term repayments, a construction loan allows the borrower to take out money to build a new home or rehabilitate an existing house.

Pros and Cons of Home Construction Loans

Construction loans are a temporary solution to pay for a new home build or a remodel. Construction loans are only meant to provide funding while the project is ongoing. Once the build is complete, the borrower is typically given the option to roll the loan into a mortgage. Since interest is only being paid during the construction phase, the financial burden is minimum. According to the experts from Construction Loan Center, these loans allow families to pay on their current mortgages without the financial strain of paying for two mortgages.

The biggest risk of a construction loan is that the final value of the home is less than the project cost. However, choosing a reliable builder will help negate this risk. Homeowners should also conduct independent research before starting a project to ensure the remodel has high potential for offering a substantial ROI. Another potential downside of a construction home loan is the project falling behind schedule. If the work isn’t completed on time, the borrower will be responsible for paying the mortgage on potentially two properties.

How do construction home loans work?

A critical question to ask any lender is “How do construction home loans work?” Each lending institutions will have their own sets of rules. For instance, the term for the loan is based on the projected timeframe of the project. Single-family properties may have a maximum term of 12 months for the loan while multi-family homes will have a term of 24 months. Construction home loans are interest-only types with adjustable rates. The permanent loan term will not commence until construction is completed. The lender will perform future value appraisals for the property to calculate loan amounts.

One drawback of construction loans is many lenders have strict application processes. To get approval, borrowers need to provide a detailed outline of the project and a timeline of when work will be completed on the property. Another part of the approval process is providing budget estimates for the home build. Based on the construction timeline, a disbursement schedule is arranged by the loan institution.

Rates and terms of construction loans will vary based on the scope of the project and an applicant’s credit history, adds Construction Loan Center. Lenders may offer traditional construction loans and construction loans with backing from the FHA.