Construction of your house is going on at a normal pace when the depleting finances threaten to disrupt the process. The derailment in the construction activity will significantly increase the cost of construction. If arranging finance within such a short notice is turning out to be a difficult proposition for you, then a construction loan will be helpful.
Construction loan is a short-term loan unlike mortgages and home loans that have a protracted repayment. The loan provider in this case will offer the loan until the borrower regains the occupancy rights to the home. This means that as soon as the borrower completes construction and makes the home as a primary residence or a second home, the loan is due for repayment.
There are no standardized guidelines to state the terms of the construction loan as in case of mortgages, which are governed by the rules made in Financial Standards Association (FSA). Depending on the individual case specifications and the degree of consideration that a borrower receives from the lender, a borrower may be able to get construction loans at differing terms.
The rate of interest for instance will be derived depending on the stage at which the construction is, and with all parties to the agreement, i.e. lender, borrower, and contractor (if any) consenting to the rate found. Since it is a short-term loan, construction loan borrowers must be prepared to shell out a greater amount as the rate of interest. Mostly the rate of interest is charged on the basis of adjustable/ variable rates.
Another distinguishing feature of construction loan is that it is generally repayable through small interest-only repayments. This makes them more convenient for borrowers since the repayable instalment further lessens. However, this may be taxing for people who will find it difficult to arrange the entire amount immediately after completing the construction of home, which in itself is an expensive affair.
For long-term financing needs, the construction loan has to be converted into a permanent loan known as a take-out loan. The conversion gives additional finance to the borrower along with an extended term of repayment. Till the borrower finishes construction, it is a construction loan. As soon as the construction is over, the loan is converted into a mortgage.
However, this has its drawbacks. Borrower is locked in the deal at the terms of the lenders. The options available are limited. Either accept the terms of the lender or make an immediate repayment. And a majority of the borrowers go for the former, i.e. accept the deal being offered by the loan provider.
Rate lock is an important method by which borrowers can escape the vagaries of the interest rate. The method of rate lock does not allow the rate of interest from rising beyond a certain level. The number of days that the borrower wants the rate lock to be in effect will decide its price. Rate locks are typically for a period ranging from 30 to 60 days. Rate locks become a limitation when the rate outside fall further.
In construction loans, as in case of mortgages and secured loans, home is in equal danger of being repossessed for non-payment of the amount due. As per the rule, the borrower has to put his primary residence as collateral. Expert advice thus holds a place of prominence in the process of decision-making. There are a number of sources from where advice may be had easily. These include an attorney, certified public accountant, or realtor unrelated with the loan providing organisation. Individual prudence also needs to be applied because it is the individual who is better aware of his financial circumstances and thus the best decision maker.
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