About Construction Financing

Construction financing can be anything from cash on hand to the most common loans. Unlike typical mortgages, construction loans come in three forms and have short-term limits. At the end of the term, the borrower must get a traditional mortgage, the possibility of which depends heavily on the contractor. These things and more must be considered when applying for a construction loan, if you want to get your building razed without financial difficulty.

Types

There are three conventional ways to finance your construction. The first, a "One Time Close" is also called an "All in One" construction loan. This loan offers both a single close and a single rate for the construction term and the end financing. All in one loans typically allow borrowers 12 months in which to construct their facility possible penalties applied to those who go beyond this limit. Construction may begin after the loan closes.

A "note modification" construction loan, unlike all in one loans, generally offers two different rates. The first rate covers the construction term and is fixed during the construction period. The second rate is the end loan rate. The interest on the loan principle (amount obtained from the lender) is on that rate. This payment increases as construction progresses, however.

Finally, there is the "Two Time Close" construction loan. It entails one closing at the beginning of construction and a second closing at the end to refinance into a permanent mortgage. Upon closing of this construction loan, interest-only payments will be made to the lender, and increasing as construction progresses. At the end, the construction loan must be refinanced into a permanent mortgage, or the borrower must pay the principal due.

Warning

An unfinished major construction project is not only an eyesore--it's also an economic blight on a community. Developers have an obligation to thoroughly assess each cost before applying for commercial construction financing. Those who ignore budgetary issues may find themselves with a large principal payment due and an unfinished home.

Considerations

Project feasibility, project location, specialized construction, developers equity contribution, and developer's experience should be carefully considered when applying for a construction loan. Any borrower unsure about any of these issues should wait on the construction loan until he has all of the pertinent information. Doing otherwise will lead to financial disaster.

Time Frame

Unlike traditional mortgages, construction loans are always short-term. The time frame for a construction loan is based on the number of weeks or months it takes to complete the project. Upon completion, this loan is refinanced into a long-term traditional mortgage loan, or sold.

Theories/Speculation

Financial institutions provide a fixed rate for an initial period of time, then a lockable interest rate for a few years. Construction loans can be both a good and a bad move in the end, especially if the interest rate changes against the borrower's favor when construction is finished. Interest rates vary and change often, so keep this in mind when applying for a loan.