Construction Loans: How Does it Work

Posted by Isabella Smith on June 13th, 2019

The Construction Loans

The construction loans are higher in interest rates and short in duration and cover the construction cost of your house. On the other hand, the traditional loans are provided for an existing house based on the market value and current condition of the home.

How Does It Work?

A construction loan is divided into three phases and includes three parties in the process; the borrower (you), the contractor, and the bank (money lender).

Phases of a Construction Loan:

The Origination

Just like any job application, the loan provider (especially banks) checks the borrower's resume and then takes a decision whether it should offer a construction loan to the applicant or not.

Meanwhile, for reviewing loan application, they would ask a few questions:

1. What is the financial position of an applicant
2. The applicant has an account with the same bank or not
3. The contractor has experience in building a house or not
4. What is the contractor’s financial position
5. Apart from the project, what are the relationship among contractor and applicant
6. Is the project worthy
7. Cost for building a house makes sense or not

If the lender is satisfied with the answers to these questions, it will offer a term sheet of the loan.

The Disbursement

After the loan has been originated, both parties (borrower and lender) have to agree over the terms and conditions. At this stage, the loans are deployed in the construction project.

Once the loan has been approved, the loan amount will not be credited into the applicant’s bank account. It would be deployed in the construction project over a draw schedule and schedule of values.

Schedule of Values: The fixed cost and variable cost of a project.

Draw Schedule: An agreed upon timeline for disbursing the construction funds typically on a monthly basis or when an agreed upon project milestone is accomplished.

When the amount will be due, an inspector from the lender side will visit and ensure the project completion. Further, he will confirm the same to the lender and the amount would be disbursed.

The Servicing

It’s time for collection of interest over the loan. The interest could be charged over the whole amount every month or on each installment made periodically. Both of the conditions depend upon the terms of the loan.

Advantages

• No tension, until you receive the complete amount of loan:
• Until you have received the complete loan amount in full, the lender cannot charge interest. It means during the construction process, you can work to save, money for later.
• Flexible terms and conditions:

o   The banks offer flexible terms and conditions in these loans. If you introduce something new or more in the construction plan, banks can offer you more options.

• The continuous review of construction:

o   The continuous review might seem tough but it ensures that your project will get completed within the stipulated time frame and budget limit.

Disadvantage

Tough Approval:

The construction loans are high in terms of amount and interest rates. It carries higher risk. It is tough to get approval.

Higher Interest Rates:

Generally, the construction loans are for short-terms with higher interest rate. The interest rate could be flexible, depending upon the terms of the agreement.

Highly Risky:

If you had taken a construction loan, at the end of the duration you have to pay off the complete loan in full.

Conclusion

From the lender’s point of view, construction loans are riskier and from the client’s side, they are a bit tough to get approved. Before taking any construction loan, look around for an expert and calculate the risk.

If you are seeking construction loan, you can search it over Texas VA Construction Loans.