How Does Construction Financing Work?

Construction Loans

Financing construction is done through obtaining a construction loan from a lending institution. Usually construction loans are considered shot term financing solutions. Once the construction of the building is complete, the loan usually gets converted into a permanent mortgage loan.

Getting Qualified

Getting qualified for a construction loan is different than getting qualified for a home purchase loan. The lender looks at assets and construction plans. Assets lessen the risk involved for the lender. If the person defaults on the construction loan, the lender can go after their assets to repay the debt. Many people who apply for a construction loan, fully own the land that they intend to build on. The lender also looks at the construction plans. Lenders want to assure that the future building will have significant value after construction. The value of the finished building should be equal to or more than the loan.

Calculating Costs

Before applying for a construction loan, find out the estimated costs from the builder. Make sure to calculate costs of materials, permits and labor. When applying for a loan, it is a good idea to ask for at least five percent more than the anticipated costs. It is extremely common for unexpected expenses to arise during the building of a new home. Asking for more money than the predicted financial costs of the project, protects against a shortage of money in the event of unexpected costs. You don't want to run out of money before the project is fully completed. It may not be easy to get approval for additional funds from the lender.

How the Loan Pays Out

Once a lender approves the construction loan, building can begin. Different loans vary on how they work. Some lenders release the money to the applicant and the applicant pays the builder. Others pay the builder directly. In the case of the later, the builder submits itemized bills to the lender in order to get paid. The lender pays the bills after each portion of the construction is completed.

Tips on Finding a Lender

Building a home is a large and expensive project. Construction loans enable a person to finance the large expenses associated with building. Just like with any loan, shop around with different lenders to find the best rates and terms. Asking your builder can be a good way to find a lending institution to work with. Builders often have relationships with lenders. If a builder has a history with a certain lender, the lending institution may be more apt to approve the loan.