A home construction loan is an interim, short-term loan for funding a new house construction. As the construction work progresses, your lender pays out money for the loan in different stages.
The home construction loans are usually short-term for one year and availed at variable rates that keep moving up or down at prime rate. The interest rate for this loan type is higher than other mortgage loans. For gaining approval of this loan, the lender needs to see your construction schedule, realistic budget and detailed plans.
After approval, the applicant will be given a bank draft to follow the project’s different construction stages. The borrower is supposed to make interest payments at the construction stage. As the borrower requests for funds, the lender will send someone for checking the work in progress for further approval.
Types of home construction loans
There are two types of home construction loans:
- Construction-to-permanent loan
As per loan for plot purchase and construction, the applicant can borrow money for paying the construction cost of the house. When the construction is complete and they move in, the loan is transformed into a permanent mortgage.
This way, the borrower has only one set of closing cost to be paid, decreasing the number of payments they owe.
At the construction process, only interest is paid on the outstanding balance without worrying about the payment of the principal amount. When the loan becomes permanent mortgage, the loan term will be 15 to 30 years, making it easier for you to cover both interest and principal amount.
- Construction-only loan
According to this type of loan, the borrower takes two separate loans. One loan is for the construction process of the home that’s usually within a year. The second loan is a mortgage loan for paying off the construction costs.
All thanks to the construction-only loan, the borrower doesn’t require a large down payment. It is a wise option for people who already own a house and building a new home. You may have less cash initially but once your current house sells, you will have more money for paying the mortgage after completion of your house.
What home construction loans cover?
A home construction loan covers the costs of materials and works done for building a new home. Some of the items a borrower can finance with this loan are contractor labour, permits, roof framing costs, interior furnishing costs and other expenses.
How to check home loan eligibility
Eligibility for a home construction loan is usually more costly than a traditional mortgage. For traditional mortgage, the home acts as collateral. If there is default on payments, the bank may seize the home.
But for a home construction loan, lenders or banks don’t get this option. Therefore, this loan is considered to be a bigger risk. To offset this risk, lenders for home construction loan have set more stringent eligibility criteria. You need to qualify the following criteria:
- Stable income
- Good to excellent credit
- Down payment up to 20%
- Low debt-to-income ratio
The lender also asks for detailed information about the planned house size, lot, materials uses and details of contractors working on the project. If you are working with a reputed contractor, lenders are likely to trust the construction process.
How to search for a home construction loan lender
Since home construction loans are riskier than traditional mortgages, many banks and NBFCs avoid financing them. You may check out smaller credit unions or regional banks that may approve this loan.
