We can explain a construction loan as a short term loan given to home buyers and home builders which is paid after the building project is complete. These loans are given to people who are building their real homes or home buyers and not rentals. Construction loans are given for a period of one year to serve the beginning of a project before the home builder get other funding.
Interest rates of construction loans are always higher than the rates of permanent mortgage loans because they are considered riskier. According to the terms and conditions of construction loans, after the completion of the building project the home builder should get some other loan to pay this loan if they have not enough money to pay or refinance it to the level of a permanent mortgage loan and follow its criteria for payment. Different from other forms of loans, construction loans require the borrower to pay the interest until the project is complete in order to start clearing the loan. Since the loan is purposely for construction of the owner’s real home, lenders have adopted a way of paying the contractors instead of giving the loan to the borrower directly. When the lender has to pay the contractor on behalf of the builder, the money is paid in installments as at various stages when the contractors need to be paid.
It is very impossible to get total funding to build a home of your dream, and for most money lenders you are required to provide between twenty to twenty-five percent of the total construction cost. This loans are not easy to get especially if the borrower has a limited credit history or doubtful financial background. Before giving this loan the borrower must give the lender all details concerning the building including proving to the lender that the contractor involved is a qualified professional. Since this loans are very risky, Banks fear to give out money and instead these services are left in the hands of local unions and regional banks which are familiar with the area and knows at least some contractors.
Construction loans are the most optimum loans for those who intend to put up their own homes as it has many advantages, as explained below. It is advantageous when the loan lender pays the contractor instead of giving the loan to the borrower because it prevents chances of it being diverted to any other uses. Importantly, it requires the borrower to pay only the interest as the project is continuing and monthly installments after the construction is complete are lower enough and affordable and also the payable period is long enough. Taxation increases the cost of loans, but only for construction loans, costs are not subjected to any taxation making them affordable. The most important thing with construction loans is that their interest rates are based on the money market meaning when the market is high, the interest is lower.