Constructing your own home is better than renting a house or buying an already built home. The pride of owning a new home is wonderful and matchless. But home construction brings in huge expenses, which can be difficult to manage for most people. Here is where a construction mortgage comes in handy.
There are many things to consider and learn before applying for a mortgage. Here is a detailed guide explaining a home construction loan, benefits, application process, and how they work for the borrowers.
Why choose a home construction loan over other financing options?
Here is why home construction loans prove to be a better option:
The mortgage gives you the freedom to build your dream house
A construction loan is a perfect financing option for building your property as you like. Unlike other loans available for buying, a pre-constructed property mortgage allows the borrowers to build a home as per their liking and preferences using top-quality construction materials. From design to colour and structure, you can choose every element of your home.
Cost-effective option for financing home construction
The best thing about a home construction loan is that interest is levied only on the disbursed amount. In other words, the interest amount isn’t calculated on the entire sanctioned amount. Once a part of the construction process is completed, the next slot of the loan amount is credited into the borrower’s account, and the interest is charged accordingly.
Construction mortgages can be used for multiple purposes besides home construction
You can use the loan amount for extending, rebuilding, or renovating your house. The loan amount can be used for adding a new room or a new floor or making any changes in the existing area of the property. You can elevate the comfort level of your home without worrying about expenses.
How do construction loans work?
Generally, construction loans have variable rates (the prime rates increase or decrease according to the market situation). However, interest rates for construction loans are comparatively higher. In traditional mortgages, borrowers need to extend an asset as collateral so that the lender can recover the loan amount in case of default payments. A home construction loan doesn’t give this option to the lenders. Hence, the risk rate is bigger than the interest rate.
Construction loans are timetable oriented and dependent on project completion. Borrowers must provide the details of their construction timeline to the lender, a realistic budget, and detailed construction plans.
Once the loan is approved, borrowers need to draw a schedule detailing the different construction stages of a project. During the construction stage, borrowers need to make interest payments only. And the lender disburses money in different stages as the construction work progresses.
Borrowers can draw the construction loan money after completing every milestone (such as building the foundation, the beginning of the building’s framing, etc.) of the construction project. Individuals need to repay the interest only on the amount used for the construction.
During the period of home construction, the lender ensures regular checks of the work in progress through an inspector or appraiser. After the appraiser approves, the lender disburses the progress of the construction process by an additional amount. You can expect five to seven inspections during the entire construction period.
Once the building, the borrowers may convert their construction loan to a mortgage depending on the terms and conditions of their loan, which is termed as a construction-to-permanent loan. However, if the borrower only takes a loan for the construction period, they may need to sign up for a separate mortgage to repay their construction loan.
Stages of construction loan
Generally, the construction process has five stages. Once a stage is completed, borrowers must submit the receipts, relevant claims, and invoices to the loan provider. Here are the details of the five stages, along with the percentage of loan funds that goes into each stage-:
1. Concrete slab
The first stage involves laying the foundation of the building. Builders make the concrete slab according to the pre-decided design and structure. This stage involves pouring the concrete according to the measurements, connecting drains and plumbing, and other related processes. At this stage, approx. 15-20% of the construction loan fund is used.
2. Laying building frame
In the second stage, the builder focuses on the structure of the building. It usually takes a day to build the frame for a single-story property, whereas a two-story property’s frame building takes a week. It takes 20% of the loan amount to fund this stage.
3. Putting up building components
It’s the lock-up stage where the contractor works on the exterior of the building begins, and the structure starts to take its shape. It involves building external walls and installing doors, windows, roofs, and other components to the property. Approximately 20% of the funds are required at this stage.
4. Internal fitting and installation of fixtures
When the structure is secured, the contractor works on the new building’s fittings and fixtures (such as plumbing and lights). At this stage, they also work on installing cupboards, benchtops, etc. Around 30% of the construction mortgage is used up at this stage.
5. Final touches
The final stage involves:
- Fixing the loose ends of electricity and plumbing.
- Completing the details.
- Cleaning the site to make the newly constructed building look presentable.
Approximately 10% of the net construction mortgage value is needed at this stage.
Anyone can apply for a construction loan, given their eligibility criteria. Applicants should have an excellent credit score, proof of income, and a low debt-to-income ratio to qualify for a construction mortgage. There could be additional terms and conditions which vary from lender to lender.
Besides, many lenders check the applicants’ home/building construction plans before approving their applications. It is recommended to present a detailed plan to gain the confidence of the lenders. Add an appraisal highlighting the detailed estimate of your construction project. It also assures them of your capability to repay the mortgage. If need be, take the help of a professional builder or a construction company to plan things.