A construction loan is a short-term financing solution intended to support the construction or renovation of residential real estate. Unlike traditional mortgage loans, funds from a construction loan are typically disbursed in stages, based on the progress of the construction project.
Key Features of Construction Loans
- Short-Term Financing: These loans typically span between 6 to 12 months, depending on the project’s size and timeline.
- Draw System: Instead of receiving the full loan amount upfront, funds are released in increments, or “draws,” at various stages of the project (e.g., after completing the foundation, framing, etc.).
- Higher Fees: Because of the greater risk involved for lenders, these loans tend to have higher fees than traditional home loans.
- Repayment: Each lender will have specific requirements for repayment. At Saco & Biddeford Savings Institution (SBSI), construction loans require interest-only payments during the building phase and then convert into a traditional mortgage once the construction is finished.
- Down Payment Requirements: You typically need a larger down payment, typically between 10% and 20% of the total projected cost of construction. If you’re building on gifted land, that value may count toward your down payment.
How Construction Loans Work
- Loan Application: You’ll need to apply for a loan by providing details of the project, including blueprints, building permits, and cost estimates.
- Approval Process: The lender will assess your creditworthiness, the project’s feasibility, and the projected costs.
- Funding: After approval and closing, the loan is disbursed in phases based on the progress of construction. Each draw is preceded by an inspection to ensure the work aligns with the plan before the next draw is made.
- Completion & Transition: Upon completion of the project, you may transition into a permanent mortgage for the remaining term of the loan.
Benefits of a Construction Loan
- Flexible Financing: This loan allows you to borrow the funds necessary to complete a custom home or renovation.
- Interest-Only Payments: You only pay interest on the funds that have been drawn, which can reduce your financial burden and manage costs early in the process.
Things to Consider
- Timeline and Budget: Construction delays and cost overruns can affect both your loan and project timeline.
- Lender Requirements: Lenders may require that you use licensed contractors and may conduct inspections at various stages of construction.
Overall, a construction loan can be a powerful financial tool to help turn your vision into reality. It's important to thoroughly research the loan terms and consult with a qualified lender to determine whether a construction loan aligns with your needs and financial situation.
This is the first article in our two-part series on understanding construction loans. Click here to read the second installment.
