Construction Loans: All You Need To Know!

At some point mortgage loans seem to be declining due to the current financial situation which is public and notorious. However, construction loans have not dropped and are increasing month after month. Sadly, people are not well aware of how these loans work and what they are. If they did, they would definitely resort to them because many people’s dream is to design their own home right from the beginning. Following is some basic information about construction loans that everybody should know:Construction Loans: The ConceptThese are loans that provide funding to finance the building of a new property. They can provide the funds for the land purchase though it is not strictly necessary. The money can be handed in altogether or in several stages along the construction project. Also, it can be customized as a line of credit where the borrower can withdraw the money as it is needed to pay for the construction costs. The loan can be secured with the land and with the property or the materials as it is being built.Given that the property does not exists yet, the interests on these loans are higher than mortgage loans and they can be reduced when a construction stage is completed and the property-to-be starts acquiring value. One may wonder where are the benefits if financing a construction project is more expensive than financing the purchase of a home in terms of interests. Truth is that building a property is still far cheaper than purchasing an already built one and therefore, the extra costs of financing are not that significant.Repayment Schedule and Emergency ReserveThe repayment depends on the nature of the project. If the project is commercial and it can start producing revenues before completed, the payment can come out of the profits and start up in full fairly soon. But on residential projects, the repayment is distributed along time according to the amounts withdrawn for the project. Basically, instead of a loan, the funding is instrumented as a line of credit and the constructor obtains the money needed for each project stage and only needs to repay the proportional principal and interests with each installment. Make sure to check the terms of the loan and whether you are charged interests on the whole loan amount or only on the amount withdrawn.The emergency reserve, also known as contingency reserve is an amount set aside to compensate any market variations that can occur. Construction materials have variable values and a project may turn out to be more expensive than expected. Without this emergency reserve or contingency funds, the applicant can fail to cope with the project costs which would endanger both the project and the lender’s investment. In order to avoid this, lenders require constituting this reserve above the loan amount requested to afford the construction costs budgeted and any additional costs that may arise.Loan Amount and Loan ConversionThe loan amount will of course be limited to the likely value of the finished property. The reason is simple, when the project is finished after a year or two, the construction loan is converted into a definite loan in the form of a mortgage loan unless the borrower has the necessary funds to cancel the rest of the loan principal. Therefore, the loan amount that you could obtain with the mortgage loan of a property of similar value is the figure that will be used as basis to calculate the construction loan amount along with other variables like the applicant’s credit and market conditions.