A construction loan is one that allows a person to purchase a piece of land or an existing home and at the same time obtain the necessary funds to build or rehab a house. The key factor to a construction loan is that it allows a person to take ownership of a piece of land or an existing home and then build or rehab it to meet one's needs or desires.
Banks and Mortgage companies typically offer two types of construction loans:
1) TRADITIONAL CONSTRUCTION LOANS
The traditional construction loan is a short-term loan used solely to fund the purchase of a property or land and to for the construction costs. To purchase and build/rehab a home you would be required to obtain two loans to complet the process. The first loan allows for the purchase of the property and funds the construction. Borrowers would typically then need to obtain a new loan for their permanent financing. Typically you will pay one point (one percent of the loan amount) and closing costs for this loan.
a)The buyer purchases the property utilizing the contruction loan and their downpayment funds.
b)The construction takes place with the loan funds equally disbursed in 6 installments according to a disbursement schedule.
c)The last disbursement takes place once the construction is finished and the borrower has obtained an Occupancy Permit. During construction the loan payments are made on an interest only basis.
d)The borrower refinances his completed home with a new loan, paying off the construction loan.
THE BENFITS OF A TRADITIONAL CONSTRUCTION LOAN
* By utilizing two loans, one for the purchase/ construction and on for the permanent financing a borrower may be able to obtain better rates for both loans.
THE DETRACTORS OF A TRADITIONAL CONSTRUCTION LOAN
* Two closings therefor two sets of closing costs
* You will need to qualify for permanent financing at a later date. There is always a risk that you will not be able to obtain permanent financing.
* Short term interest rate risk: rates may go up during construction.
2) ONE STEP CONSTRUCTION LOANS
A One Step Construction Loan is one that provides both construction and permanent financing in one loan program. This loan has three parts; the first allows for the purchase of the property, the second funds the construction, and the third provides permanent financing for the home.
a) The buyer purchases the property (via downpayment funds and loan funds)
b) The construction takes place with the loan funds equally disbursed in 6 installments according to a disbursement schedule.
c) The last disbursement takes place once the construction is finished and the borrower has obtained an Occupancy Permit. During construction the loan payments are made on an interest only basis.
d) Once the Occupancy Permit is obtained the loan will then start amortizing according to the loan terms chosen at the time of application.
THE BENFITS OF A ONE STEP CONSTRUCTION LOAN
* One closing and one set of closing costs
* Ability to lock in a rate for permanent financing prior to construction thereby eliminating interest rate risk.
THE DETRACTORS OF A ONE STEP CONSTRUCTION LOAN
* The rate for permanent financing may not be as attractive as one obtained by a non-construction loan program
CLOSING COSTS FOR A CONSTRUCTION LOAN
The closing costs for a construction loan will include the standard closing associated with the purchase of a property plus those associated with the construction. The addition costs associated with construction are usually those incurred in the loan disbursement process. At each disbursement the lender will send out an inspector to check the work, and do a title run down on the property to make sure no additional liens have been placed on the property. The costs per disbursement are usually between $100-$200 and up to 6 disbursements may be necessary.
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