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Should I get a construction loan for remodel? Constructing a house is a lifetime investment. But unfortunately, it is a challenging endeavor for many. This is especially true if you luck savings to fund your construction.
Planning to construct a house, but you are tight on budget? A construction loans is a better way to get you started, but is it really worth it?
In this article, we will provide you with an extensive overview of everything you need to know about construction loans, how they work, the rates, renovation loan vs. construction loan, and more.
What is a construction loan?
Let’s understand construction loans in the simplest way.
A construction loan is a money borrowed to cater to your home construction needs. It is mainly given to people planning to construct their houses from scratch. A construction loans is usually short term (mostly about one year) and comes with higher interest rates. So, you have to sacrifice any rates you get locked into. Simply say, a construction loans is money used to cover expenses associated with building a brand home, such as labor, materials, land, permits, etc.
Construction loans have a progressive drawdown. That is, the lender pays the general contractor in installments as they finish building every phase of your home. Once your house is completed, you have two options: Pay your loan fully or convert it to a permanent home loan (also known as a mortgage).
Types of Remodeling Home Loans and What You Can Do
Remodeling loans are specifically designed to cover more minor expenses such as repairs, cosmetic changes, upgrades, etc. Remodeling home loans are pretty versatile and have minimum loan requirements. Use renovation loans to cater to costs associated with things like;
- Upgrading your kitchen or bathroom
- Repairing or replacing your roof shingles
- Repairing or installing heating and cooling systems, plumbing, or electrical
- Remodeling your basement
- Getting new doors, windows, or floors
- Purchasing new construction appliances
- Landscaping and more
Some remodeling home loans can be used to cover major expenses such as;
- Adding rooms
- Repair that takes longer than six months
- The new renovation that demands structural repair/changes
How do construction loans work?
Construction loan works in a simple way. Before you receive these money, the loan provider will want to know the plans and the budget you set. This information will help the lender determine the loan amount you qualify for.
Once approved, you don’t get the money. Instead, the lender pays the contractor in installments (commonly known as a draw). The lender also checks the home renovation/construction progress before releasing additional money.
Every draw helps to keep the project going as per the schedule. Most lenders offer a 5-7 draw schedule, while others may give more. For example, the first draw to cover costs associated with land and permits. The next draw goes for framing and subflooring, and so on.
Some lenders may require borrowers to make interest-only payments during the construction phase. It means you don’t have to pay for the principal until your project is completed.
Once your project is complete, you can now start repaying your loan. In this case, your construction costs are rolled into a mortgage. This means you will make monthly payment.
FHA 203(k) loans
These are types of loans that are insured by the Federal Housing Administration. They usually come in two categories: standard and limited.
The standard loans are specifically meant for major structural repairs, upgrades, and other home renovation fund projects. In most cases, this type of loan can cover expenses worth up to $5000.
On the other hand, the limited category of FHA 203(k) loan is capped at $35000. It is mainly used to cover home renovations. However, this type of loan doesn’t include structural repairs.
The advantages of FHA 203(k) loans may include;
- Easy and secure way of getting money because they are insured by the government
- No need to be the initial home buyer
- Low mortgage rates
The downside with these types of loans is that you have to use an FHA-approved lender.
Operated by Fannie Mae, HomeStyle loans are flexible and have minimum restrictions. These loans usually offer 75% of the total purchase price, plus the home improvement cost. In other words, qualified applicants can get 75% of the finished appraised value of your home.
So, if you are planning to refinance your house, the lender will give a detailed cost estimate of the value of your home plus the post-renovation projects. For instance, if they find the future value of your home renovation after completion will be $400000, then the amount you receive will not exceed $300000.
Some of the advantages of HomeStyle loans include;
- No strict requirement on what to do with the money
- You can use the money on an investment property
- Allows borrowers to include up to six months of mortgage payment in their loans until renovations are finished
The disadvantage with HomeStyle loans is that you must hire a licensed contractor to estimate the value of your property before your loan gets approved.
Managed by Freddie Mac, CHOICERenovation loans work the same as HomeStyle loans. It offers 75% of the lump sum of the value of your home plus the post-renovation projects.
The advantages of CHOICERenovation loans include;
- No restriction on what to do with the loans
- Fixed and adjustable rates
- Minimal or no pay closing costs
Construction loan rates
Home construction loans rates vary from lender to lender. Regardless of the lender, the rates tend to be higher than regular mortgages. Expect to pay about one percent higher than conventional mortgage rates in most cases.
Sometimes construction phase loans are also given as interest-only loans. In this case, borrowers need to pay interest on money borrowed without paying any part of the principal loan balance. And this makes the repayment more feasible.
With home construction mortgage, you pay interest on funds already being disbursed. For instance, if $200000 is borrowed, and only $20000 has been released, you only pay interest on $20000.
Like other personal loans, a loans score can affect the amount of money you receive and what you can pay in interest. So, the type of lender you choose matters quite a lot. The rates are variable and can fluctuate depending on many factors.
Home Renovation Loans
Renovation loan is used to fund home renovations, remodels, repairs, and upgrades. Home renovation funds are a perfect solution if you want to renovate your current house or want to buy a property that requires a significant upgrade.
Home renovation project funds are also called FHA 203(k) loans. All legible loan borrowers can access these loans via HomeStyle renovation (Fannie Mae) and CHOICE renovation (Freddie Mac).
Other home remodeling loans include HELOC (home equity line of loans), which is best known for its adjustable rates. HELOC also promises to offer minimal or no closing costs to discerning borrowers.
Or, if you want quick and easy home improvement loan that require no paperwork, opt for loans cards. One of the fascinating things about loans cards is that there is no need to fill out a loan application. Additionally, there is a no-interest option available.
Can a Construction Loan be used for Remodeling?
This mortgage is specifically meant to cover costs associated with building a brand home. It is the money that your lender pays to the contractor directly. Although the loan provider can approve borrowers for a certain amount, the contractor gets the actual money for the work done. This means you won’t get any extra funds left. Equally, the lender wants you to pay for the money (plus the interest) it gave to the general contractor.
If you are interested in home remodeling, several financing options for renovation loans are available.
The loan process for construction loans
In most cases, the construction of your house starts once the loan deal is sealed. Also, lenders do not disburse all money at once. As mentioned earlier, your lender will release money in draws as per the construction plan and schedule. Let’s have a look at how the process works;
The contractor draws on the loan.
With a construction loan, money is paid to the builder after making a request. The lender organizes an inspection for each disbursement to ensure the project is progressing well and meets the standard requirement. Before the lender releases the next batch of money, ensure the contractor has settled all dues to their suppliers and general contractors.
How loan providers release money
Most lenders use two standard methods of disbursing money. The first common method is releasing money every time the builder completes the set milestone for a given period. The second method involves releasing money on the percentage of completion. The percentage completion method is more familiar with custom homes, where constructing phases are pretty expensive than others.
Your payments during the construction phase
Most lenders allow borrowers to make interest-only payments during the home construction phase. The interest rate you pay is determined by the amount lenders pay to the contractor. Once your house is completed, your personal loan is converted into a mortgage which you will settle in monthly payments.
Qualifying projects for these loans
There is no need to go for construction loans if you seek to renovate your house. Construction loans are money specifically used to pay for the expenses of building a private home, a commercial resident, and an office.
Also, if you plan to build a facility or industry and your current financial situation doesn’t meet the projected budget, a construction loans is worth considering.
Construction loans and existing mortgage
Construction loans are short term loans to help you build your dream home. They mostly have a lifespan of one year, and their interest rates are high. Construction loans are different from an existing mortgage because they are riskier. Also, their approval process is different than the traditional mortgage.
Another difference is that construction funds are paid out as the project progresses. In other words, the money is broken down into draws, and the funds are released as each milestone, or a certain percentage of work is completed. Lenders always keep inspecting the progress and sometimes send their staff for inspection.
The qualification requirement also differs. In fact, mortgages require low down payment than construction loans. The current mortgage average down payment for many construction lenders is 75%. You only need to fork out 25% of your own cash to qualify for a construction loans.
While construction loans can be converted into standard mortgages, the two are different. And their differences include the period, the disbursement, and interest rate, among others.
What conditions do construction loans require?
Construction loans, especially for large homes and projects, come with strict requirements before the bank releases its cash out refinance. To qualify for this loan, you need to satisfy specific necessities such as hiring a qualified contractor, a construction plan, and an appraisal. Also, you must have a sizable down payment which usually ranges between 20-25 percent, depending on the lender you choose.
Like any personal loan, lenders also review your loans score. So, ensure you have a good loans score before deciding on construction loans. This involves making larger purchases a few months before going for a construction loans. Generally, a loans score of 680 is the minimum score for most lenders.
As with loans scores, lenders will also want to review your income status. They will request financial documents for verification to confirm if you are in the position to repay your loan.
What banks offer construction loans?
There is no doubt that banks also offer construction mortgages to their potential customers. One of the best lenders you can find is Nationwide Home Loans Group. This is a division of Magnolia bank, focusing on providing low-interest construction loans to members.
Want a 30 years construction loans term? TD Bank is waving at you, and it comes with adjustable-rate options. Other banks may include VA Nationwide Home Loans (a division of Magnolia Bank), FMC Lending, and Normandy.
Who offers FHA construction loans?
There are a lot of lenders who work with the FHA to provide FHA construction mortgages. So, if you are considering a 203(K) loan, look for a consultant in your local residence at HUD.gov. Only FHA-approved lenders provide FHA construction mortgage.
Who offers USDA construction loans?
Qualified members can apply for a USDA construction loans through USDA-approved lenders. Some include PNC, Flagstar Bank, SunTrust Mortgage, and more.
Who offers VA construction loans?
VA construction mortgages can be obtained from your VA-approved lenders like security America mortgage.
How long are construction loans?
Construction loans are short term loans to cater to the costs associated with building. Instead of 20 or 30 years terms like standard mortgages, the lifespan of construction loans is 12 months. However, most lenders will extend the payoff period to 18 months due to construction delays and other factors.
Even if it is a construction-to-permanent mortgage, most lenders require their borrowers to repay their loan after 12 months. Once the loan has been converted to a mortgage, it can be paid off in about 15 to 30 years, depending on your lender.
Construction loans can sure turn your dreams into a reality. You can plan, build, and finish your home with whatever financial path you choose to get you there. Whether you are looking for a construction loans or a home remodeling loan from home equity, or any other a variety of options, realizing the right way doesn’t seem to be complicated.