Construction loans are used to pay a builder for the construction of a home. This construction could be the building of a new structure or extending an already existing structure. Three common types of construction loans are available, each with their own set of advantages. Some of the loans share advantages, however each of them has their own distinct features.
Monthly Interest-Only Payments
A separate permanent loan consists of two steps. The first step is a loan that will pay for the building of the home. The money is withdrawn on an as-needed basis and interest-only payments are made to the lender. Once the construction of the home is complete, the entire balance of the loan becomes payable. In the second step, another loan is taken out to pay the balance on the first loan. The advantage is the borrower has the benefit of paying a lower payment during the construction of the home.
Set Interest Rate
A modifies-to-a-permanent loan combines the process of the separate permanent loan. The same lender is used for both the construction and permanent parts of the loan. Both loans offer interest-only payments during the construction of the home, however once the construction is completed, this loan modifies to a permanent loan automatically. The lender can offer a set interest on a modifies-to-permanent loan, because of the assurance that the customer will continue to use their mortgage service. The advantage is the borrower keeps the same interest rate on both parts of the loan instead of risking that interest rates will increase from the start of building to completion.
No Initial Payments
The no-interest-payment loan’s advantage is no payments are made during the construction of the home. It is similar to the modifies-to-a-permanent loan, because it automatically transitions into a permanent loan. The main difference is the borrower doesn’t have to make any payments during the construction of the home. The interest payments will be financed in to the permanent loan.