Whether you are looking at commercial properties or trying to build your dream home, a construction loan is a great way to finance your project. Learning what a construction loan is, how it works, the types of loans you could get, and the requirements for obtaining one can help you decide what the right option is for you.
What Is a Construction Loan?
A construction loan is a short-term, high-interest loan that covers the cost of building or remodeling a residential or commercial property. A traditional mortgage loan has a lower interest rate because the property is considered collateral. If you don’t pay your mortgage, the bank can take your property. When you are building a structure, that collateral doesn’t yet exist, so the risk and interest rate for a construction loan are higher.
Most construction loans last only one year. During that time, you must build your property and secure a certificate of occupancy. Construction loans usually cover the cost of land, construction plans, permits, fees, labor, materials, closing costs, and contingency funds.
What Are the Types of Construction Loans?
There are several kinds of construction loans you can get, depending on your needs and circumstances. These include:
Construction-to-Permanent (Single-Close) Loan
A construction-to-permanent loan, also called a single-close loan, bundles your construction costs and mortgage together. With this kind of loan, you pay only one set of closing costs, and interest rates are locked in at closing. During construction, you make interest payments only. After construction is complete, your mortgage includes both interest and principal. A construction-to-permanent loan is a great option for those who already have construction plans, want to save money on closing costs, and prefer to lock in an interest rate.
A construction-only loan pays just for the successful construction of a building. With a construction-only loan, you must either secure a mortgage or pay off the loan by the maturity date (usually a year). This kind of loan has two sets of closing fees, one for the construction loan and one for the mortgage.
A construction-only loan can be riskier than a construction-to-permanent loan. If you are unable to pay off the loan or secure a mortgage, you risk losing your property. A construction-only loan is a great option if you have a lot of cash on hand or want to shop around for a mortgage lender during construction.
Renovation Construction Loan
A renovation construction loan is a great way to purchase a building that requires a lot of renovations. This kind of loan usually includes both renovation costs and a mortgage. The total amount of a renovation construction loan is based on the value of the property after renovation. You have several options with this type of loan:
- A short-term multifamily loan is a hard money loan used to purchase, renovate, and resell a residential structure with four or more units. This kind of loan can also be used to season, update, or increase occupancy in a multi-unit building.
- A commercial bridge loan is a hard money loan that acts as a “bridge” until more traditional forms of capital can be secured. This kind of loan can be used to renovate a property, pay off older commercial property loans, purchase a fast-moving property, and cover disaster-related repair costs while insurance claims are being processed.
Owner-Builder Construction Loan
An owner-builder construction loan is a loan where the borrower is also the home builder or general contractor. These loans are often difficult to obtain unless the borrower is a licensed builder with lots of experience and a thorough understanding of building codes.
Hard Money Construction Loan
Hard money construction loans, also called private construction loans, don’t have the same requirements or restrictions as a construction loan from a traditional bank. This flexibility allows the hard money lender to offer more personalized loan terms. With a hard money construction loan, you must purchase the real estate and invest some of your capital into the building project. In addition to providing the benefit of flexible terms, hard money construction loans can often close very quickly, such as in days instead of the weeks or months traditional loans usually take.
Spec Construction Loan
A spec (short for speculating) construction loan is a loan that covers only the construction costs of a property. This kind of loan is beneficial when a borrower is speculating that they can sell the finished property for a profit.
An end loan is the mortgage loan secured after the construction phase is complete. An end loan requires its own set of closing costs.
What Are the Requirements for a Construction Loan?
If you are ready to build your dream house or business, you might wonder how to go about getting a construction loan. Some requirements for a construction loan include:
- You must have a low debt-to-income ratio. Most lenders prefer that your debts are not more than 45% of your income, but the lower the better.
- They usually require a strong credit score of 680 or higher.
- New construction loans generally require a down payment of 20%-30%, but a renovation loan may be lower. Your down payment must cover the costs of both land and building. If you already own the land, you can use it as equity for your construction loan.
- You must have a repayment plan. If you are trying to get a construction-only loan, you must have a plan for either paying off the loan or securing a mortgage when the construction is complete.
- You must provide detailed construction plans, a budget, and a timetable for completion.
How Does a Construction Loan Work?
With a traditional mortgage, the lender pays out a lump sum that covers the entire cost of your property at closing. With a construction loan, money is paid out on a schedule that correlates with your construction timetable. Each payout (or “draw”) covers only the costs for one phase of the construction project. Before each draw, your lender will perform an inspection to ensure that the project is being completed according to the schedule.
Payouts on a construction loan are made to your builder or contractor. When the project is complete, the total cost of the loan needs to be paid off or moved into an end loan/mortgage.
If you are thinking about building or renovating a property, a hard money construction loan can help you get the funding you need to get the job done quickly. If you are looking for construction hard money lenders in Florida, contact the experienced commercial construction lenders at Titan Funding. We help our clients find the right loan solutions for their unique needs.