What is a construction loan?
Construction loans are short-term loans for investors who need financing to build a personal home, an investment property or investment properties. Construction loans are considered high risk and require a higher interest rate. Borrowers typically rollover these loans into long term financing and secure a lower interest rate now that the property or properties are no longer under construction and are stabilized. Construction loans aren’t only for the development / construction of new homes; construction loans can be used to fund renovations / rehabilitation projects.
Lenders will require a real estate developer to provide an in-depth business plan for the construction process, as well as show proof of the contractor’s experience and qualifications. On average, lenders will require a minimum down payment of 20% for construction loans and a strong credit history. Lenders can structure the construction loan as an interest only loan where the borrower will only be required to pay interest monthly but will owe the entire principal balance at the end of the project or loan maturity.
Lenders might issue the project funds directly to the contractor building the home or homes, rather than issuing the funds directly to the borrower. The contractor would receive the funds in either a lump sum payment or in monthly installments. Lenders go directly to the contractor to decrease the risk of the funds being misused.
Who qualifies for a construction loan and who might not?
Construction loans are a go-to product for real estate developers, real estate investors who have built their business around a fix and flip strategy or a build to rent strategy, and people looking to build their residence to their own personal specifications. The only way any of the above wouldn’t qualify is if they intended to act as the project’s general contractor. Unless they have a proven track record of doing this successfully, they probably won’t get approved unless they find a new general contractor with the proper qualifications and experience. Otherwise, these borrowers will be directed to an owner-builder construction loan.
When should I start the refinancing process?
On average, construction loans last 12 months and the refinancing process can begin immediately after construction is complete. Why? Risk decreases significantly as the property has successfully completed the construction process. The property is considered stabilized, and ready to sell, rent or live in.