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How Construction Loans Work

Building a custom home is an incredibly exciting process, however, paying for the construction isn’t as exciting or fun as watching your home come together. When you initially begin planning your custom home, it is essential that you build out a budget so that you know what you can and cannot afford. There are many avenues you can choose from to ease the burden of paying for your custom home, and many homeowners choose to go with construction loans. Let’s take a look at construction loans and what you can expect from them. If you need more information, do not hesitate to contact our custom home builders in Colorado Springs — our team looks forward to helping you

 

What is a Construction Loan?

Construction loans are designed to make financing your home build much more convenient, affordable, and streamlined, no matter if you already own a lot, are building your primary residence, or remodeling your current home. But what does it cover? Is it right for you? A home construction loan is a short-term, higher interest loan that provides the funds required to build a residential property. These loans are usually one year in duration, during which time the property must be built and a certificate of occupancy issued. 

Construction loans are used to cover the costs of work and materials for new-build homes, and you can use this loan to finance permits, contractor labor, home and roof framing costs, interior finishing costs, and many other expenses involved in building a house. However, it is important to note that removable items, like furnishings, cannot be included in home construction loans. Landscaping, trees, and grass can all be covered in a construction loan, but patio furniture cannot be covered. 

 

How do Construction Loans Work?

Construction loans have higher variable rates that move up and down the prime rate. They are typically much higher than traditional mortgage loan rates because there is no collateral, so banks view these loans as higher risk. Furthermore, because construction loans operate on a much shorter timetable and are dependent on the completion of the project, you will need to provide the lender with a construction timelines, detailed plans, and a realistic budget.

Compared to personal loans that make a lump-sum payment, the lender pays out the money in stages as work on the new home progresses. Borrowers are typically only obligated to repay interest on any funds drawn to date until construction is completed. Depending on the type of construction loan, the borrower might be able to convert the construction loan to a traditional mortgage once the home is built. Either that, or the borrower may be required to get a separate mortgage designed to pay off the construction loan.

 

How Will the Builder Get Paid?

The builder will get paid according to a structure set ahead of time through disbursements called draws. Essentially, this is how you might pay a builder if the money was coming straight from your bank account. The builder will be paid out upon completion of different major elements of the process, such as framing, plumbing, etc. You would continue to just pay the interest that is owed. Once the house is 100% complete, the builder will have been paid all that they were promised for their work. This is when your loan converts to a permanent loan, and you begin paying the bank back on the money that they have dispersed to the builder throughout construction.  

 

To End….

If you are serious about building a custom home, you will need to obtain both a construction loan and a permanent loan, otherwise known as a mortgage. The construction loan is a short-term loan that finances the construction process by paying draws to the builder as designated milestones are completed. Meanwhile, you will only pay a down payment along with the interest payments. The construction loan then converts into a more standard permanent mortgage loan once construction is finished, at which point you will begin paying back the lender on the total for the entire home, which would be the principal and the interest. 

 

Murphy’s Custom Homes works closely with each client to ensure that their custom home is exactly what they envisioned it to be. Because a custom home is such a serious commitment, we consider it a great privilege to work with clients to build their homes that reflect their lifestyle, style, and immaculate taste. For more information about how to fund your custom home, or to get started in building your dream home, contact our team today.

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