Construction Loans

Important Information Regarding Construction Loans

Definition

A construction loan differs from your average loan because it is a so called story loan. This means that creditors will not only look at credit reports and numbers and then use a formula to churn out weather you are eligible or not. They are also interested in the story behind the construction. If you are building a ten story house with your bare hands that will lean 34.4 degrees to the left they may not give you a loan, even if you have a great credit report. If your construction plans are based upon well founded ideas and a respected construction company you may be eligible even with a less-than-great credit report.

Amount

The amount that the creditor will lend is based upon all the factors defined above, but may also depend on collateral. If you own the land you are building on it may be considered as equity, thus raising the amount borrowable. This is in conjunction with the fact I said earlier, that it is a story loan. If you have a good credit report you may get a larger amount than someone earning more, with a bad credit report.

Always try to take out the amount you need, not the maximum, as many loan packages do not allow you to repay in advance. If you take out a big loan to be on the safe side, thinking you'll just repay the amount left over quickly you should rethink some stuff. Not only will the bank not allow you to do this, they will have you pay interest on everything, not just what you spent.

Repayment

The other common feature, which is great for borrowers is that until the construction is complete usually only the interest is paid in installments. Amortization only becomes due when the house is complete and you have moved in. This is convenient as you can direct you financial and other attention to the construction itself. It is also common to have a moratorium, that is a period where you don't have to repay money. You could borrow an amount 10+1 year plan. In the first year you pay nothing, then you start making the monthly payments and continue for ten years.

Most commonly, construction loans are variable interest rate loans and the interest is tied to short term rates, eg, prime rates. This does not mean though that your interest will be near the prime rate (that is a low rate). It just means that the interest goes up and down, according to the prime rate. Typically, construction loans won't be burdened with a huge interest, but it may be worth thinking about consolidating, you may be able to eliminate the variable interest and replace it with a fixed one.

A different, and maybe more convenient repayment way that is offered by most creditors is that upon completion of the construction and moving in you can convert the construction loan into a mortgage and this has various other advantages. Mortgages may mean some tax reliefs in countries, while this is certainly not the case for other loans, so even if nothing else good comes from it, it may be better.

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