Construction loans are a necessary part of the building and rebuilding process, as many homeowners and commercial landlords do not have the funds directly on hand to support new projects or renovations. Though they are similar to mortgages, construction loans do not work on the same time frames, terms or interest rates that most mortgages do, so be sure you know what you're signing up for before applying for a construction loan.
Construction loans can be used to develop residential properties, such as single-family homes or multi-family complexes like apartment buildings or condominiums, or they can be used for commercial properties, such as office buildings, retail centres and industrial complexes. Though it is easier to secure a loan for a small construction project, such as a home renovation, most providers offer construction loans for projects that must be built from the ground up.
Most interest rates on construction loans are based on the Prime Rate, which is the rate at which nearly every bank charges their "prime" customers, or those who have the best credit rating. This rate is usually very reasonable and very stable, though it is tied to the Fed's Federal Funds rate, meaning that any significant economic activity, whether good or bad, could cause the rate to vary. Some lenders allow borrowers to convert their loans to a fixed rate or fixed-period adjustable rate once construction is complete.
Most construction loans for ground-up projects require the lendee to make interest payments throughout the construction period, while the actual loan is expected to be paid 12 to 18 months after the loan paperwork is signed. If an interest-reserve account is not offered, however, then the borrower must begin making their monthly loan payments right away, regardless of the project's progress.
Many factors account for the amount you will need to borrow for your construction project. It will have to factor in the actual costs of construction, including all the materials and labour, soft costs, such as blueprints, logistics, zoning and permits, typical closing costs, inspection fees and whether or not you've already paid off the land you intend to build on. Additional fees may apply if the construction process stalls or if the loan's underwriter calculates that the project's costs were significantly higher than what was previously anticipated. This may result in a deficit for a borrower between the amount of money they can directly provide for the project and the amount the lender is willing to lend.
The collapse of the housing market and the credit crunch of 2008 caused many lenders to shy away from construction loans. However, the Federal Housing Administration revamped the FHA 203(k) construction loan program to supplement the lack of private lenders willing to back these types of loans. These loans are typically limited to single-family homes or multi-housing projects, such as condos, that contain less than four units. The loans, which can total upwards of £1.0 million, are intended to provide financing to owners who need to renovate, remodel or otherwise rehabilitate their properties. They are not to be used for ground-up construction projects.