What You Need to Know About Construction Loans

Do you have a property that you want to add on to? Or maybe you have a lot or found some land that you want to develop. In either case, a construction loan is going to be the way to finance this type of project. If you are used to traditional lending terms when purchasing a property, going through the lending process for a construction loan is a bit different. Once you understand the construction loan process, it will make it a lot easier, faster and less painful to obtain the funds you need to move forward.

Hard Money Construction Loans vs. Traditional Construction Loans

Like financing a single family or multi-family property, construction loans can be financed through traditional lenders, government lending programs or with hard money construction loans. Which option is best for you depends upon several criteria.

How soon do you need financing? While conventional or government programs might have their benefits, speed to closing is not one of them.  New construction requires a substantial amount of documentation and form filling with a traditional loan program. If you don’t have the time to wait for that, a hard money construction loan might be worth pursuing.

While hard money loans of this type might take a bit longer than a traditional single family hard money loans, you can still potentially have funds within a week or two.

So, if time is a key factor in getting a deal or staying on top of a project, hard money loans are the way to go.

Lender Documentation Requirements

If you’ve decided to move forward with a construction loan, it’s critical that you get the paperwork together that your lender is going to require in advance. The longer you spend to get everything done, the longer the whole process will take to close.

While each lender is going to have specific requirements, there are some fundamental documents that you will need with just about any lender.

  • Architectural drawings or building plans outlining what is being developed.
  • Contract to purchase or other documentation showing that you own or will own the subject property.
  • Cost estimate of the scope of work that is being done, by line item detail.
  • Up to three years of prior tax forms as well as a current financial statement. Some lenders will also be asking for bank statements as well. The objective here is to provide more than sufficient information for the lender to be comfortable with your ability to make the loan payments during the lending period.
  • Appraisal and possibly a survey of the property prior to loan approval or disbursement of any funds.

Construction Loan Terms

Construction loans are for a much shorter time period than traditional financing. Your lender will usually allow up to one year of payments before you need to payoff the loan either through a sale of the property or via refinancing.

While conventional financing is usually principal plus interest payments, you’ll find that construction financing is interest only during the loan term. That helps keep expenses lower during construction.

Some construction loans are fixed rate and others are variable. If it’s a variable loan, it’s likely to be tied to (or based on) LIBOR, which is the London Inter-bank Offered Rate, or tied to the U.S. Prime Rate. At Loan Ranger Capital all of our interest rates are fixed so there’s no need to worry about change!

It’s important to realize that construction loan interest rates are higher than a conventional financing options. Lenders have increased risk and exposure, and the interest rates that they offer reflect that. You can expect to see interest rates that range from Prime plus 2% to LIBOR plus 6%, depending upon the lender, the project and the exposure.  It’s critical that you ask your lender about their terms and compare what they are quoting to other lenders in your area.

How to Prepare

Part of the process of obtaining a construction loan will include drafting a project scope. That will require you to outline exactly what work will be done and the associated costs for each line item listed.

Your lender is also likely to require a timeline of the proposed construction. This is not the time to assume everything will go smoothly, it won’t. So, make sure that you have a bit of a cushion in your timeline for areas that slip off schedule.

Once you’ve provided that to your lender, they will create a draw schedule. Loan proceeds are disbursed to you based on the agreed upon schedule. Depending upon the scope of the project, there are usually somewhere between three to eight draws allowed.

Pay careful attention to how you will receive the draws. All too often borrowers find that they need to come out of pocket or request modifications to the draw schedule because there are shortfalls in costs that need to be paid versus funds that are being released.  This is where having a good relationship with your lender is critical!

This type of loan requires a much larger down payment than the as low as 3% that you might find when purchasing an existing home.  Construction lenders will usually require a minimum of 20% down payment in order to finance this type of project. Like we mentioned when discussing interest rates, it’s due to the increased riskiness of this type of project.

According to Realtor.com, three of the top ten hot cities that will dominate new home construction this year alone, will be in Texas! That makes finding the right construction loans and a lender critical. Using these tips, you can make the process easier, faster and better. And if we can help, please give us a call at 512-220-9916 or contract us HERE. We’d love to help you get the new construction loan that your project needs starting TODAY!

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