Construction Loans are vastly different than your average home loan in many ways. Construction Loans are given to those borrowers who are either renovating a property or building a dwelling on real estate that they own. The biggest difference between a standard home loan and a construction loan is that a construction loan is metered out in multiple payments versus getting all of the money in one lump sum with a standard home loan.
Think of these multiple payments out to you as milestones towards the main goal of receiving all of the money for the loan. These milestone payments are what’s referred to in the business as progress draws. Borrowers receive these payments as they complete sequential steps in completing their renovation project or building the home.
Progress Draws – Building A House
The usual chain of events with progress draws for building a home is that the lender will pay the builder directly as they reach certain stages of the project. These stages are as follows:
- Base – This is the very first milestone for the builder to reach as this lays the foundation (pun intended) for the rest of the project. During this stage, the builder will make sure that the ground is leveled as well as install plumbing and sewer lines and waterproof any masonry walls.
- Frame – This stage is for building the skeletal framework for the house which includes windows, trusses, roofing, and other support work such as floor joists.
- Lockup – Now the home is starting to take some semblance of shape as the exterior walls are completed with windows and doors to the property. The installation of doors is where the term “lock up” is derived from as the property can now be secured.
- Fitout – This stage covers the internal work of your property with electrical work, plasterboards, cupboards, gutter work, and plumbing.
- Completion – This is the final stage which covers finishing work to the electrical system, plumbing system, and ties up any loose ends. This stage also covers the completion of payments for equipment and contracting work done by the builders of the property.
How To Obtain a Construction Loan?
In addition to the documents that need to be supplied for a standard home loan (bank statements, credit report, etc.), you’ll also need to supply the lender with documents tied to your land. These documents include permits needed for building projects, council plans, copies of your building contract, and insurance documents related to your project.
The next stage for approval of a construction loan is a full appraisal of the property by a licenced property appraiser. The appraiser will take note of the original value of the land and the amount of money requested for the home project. The amount of money needed by the contractors for completion of the project will also be factored into the final assessment of the property. This appraisal will include an estimate of the final value of the property after construction is completed. This final value will show the lender the amount of improved value to the property compared to the amount requested, or in other words, the ROI or Return On Investment for the borrower.
Once you’ve reached this stage of loan approval from the lender, you know that you’ve been approved for the loan! The amount of required deposit can vary based on the amount needed for the project and the borrower’s creditworthiness. The usual minimum requirement needed for a construction loan is 5% down payment.
Keeping The Lender In The Know
As a condition of loan approval for the project, the borrower must supply the lender with documents that confirm that the required work has been completed by the contractor for each successful stage of the project. The lender can also submit an invoice request from your contractor to show the cost of the work completed at each stage. These documents will show the lender than the money lent out is being used for the purpose that it was intended for.
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This is an option for borrowers if they have a lot of equity in the property on an existing standard home loan. In the States, this is what’s referred to as a “home equity loan” which many homeowners use to make improvements to the property. These improvements could be as simple as refinishing a new concrete driveway to the property or as complex as adding an addition to the dwelling. We’ll look at the pros and cons of both a standard home loan and a construction loan below.
Standard Home Loan
The advantages of having a standard home loan versus a construction loan is tied to money and time. A standard home loan will have more time to pay it off and with much less deposit required. The Interest Rate on a standard home loan is much lower than a construction loan and the terms (time) to pay the note back are better as well.
The disadvantages of a standard home loan is the Principal paid out to you and the interest that starts collecting from day one. Regardless of where you are on the project, you’ll be paying a full note payment to the lender every single month.
The advantages of a Construction Loan is that they’re given out in stages versus all of it up front. This is perfect for those wishing to keep their budget at a minimum as you pay less interest over time. The amount of interest that is charged for a construction loan is tied to what you have out, not the entirety of the amount borrowed for the loan.
The disadvantages of a Construction Loan is the amount of money drawed down with each stage of the project. If your project runs overbudget during a stage, you’ll have to apply for a separate loan for that amount of money or get approval for release of the next stage of funds for the project.