How Do New Construction Loans Work?

Navigating the path of constructing a new building, whether a dream home or a business facility, can be thrilling yet intricate, especially when it comes to financing. Understanding how new construction loans work is crucial in planning your build. Unlike standard mortgages, these loans are designed specifically for financing the construction process. Let’s delve into their mechanics:  

Short-Term Loans with a Unique Structure:

A construction loan is a short-term loan, usually lasting for a year, or until construction is complete. It’s designed to provide periodic disbursements to cover construction expenses as they occur.  

Interest-Only During Construction:

During the construction phase, borrowers usually only pay the interest on the disbursed amount. This feature helps manage costs when you might also be paying for temporary housing or continuing to run your business.  

Detailed Plans Required:

To secure a construction loan, you’ll need comprehensive plans for your project. This includes architectural details, a construction timeline, and a realistic budget. Lenders must ensure that your project is feasible and can be completed within the specified timeframe.  

Higher Qualification Standards:

The approval process for a new construction loan can be more stringent than for a traditional mortgage. Lenders often require a higher credit score, a lower debt-to-income ratio, and a significant down payment, usually around 20 to 30 percent.  

Conversion to a Permanent Loan:

Once construction is completed, the loan typically converts to a traditional mortgage. This transition, known as a “construction-to-permanent” loan, allows you to finance the construction and then convert the loan into a long-term mortgage.  

Direct Payments to Builders:

Lenders usually pay the loan amount directly to the builders in installments rather than disbursing the entire sum to the borrower. These payments, or draws, are typically made throughout the construction process based on the project’s progress and pre-established milestones.  

Appraisal Based on Future Value:

The loan amount is often determined based on the projected value of the completed property. An appraisal will give the lender an idea of the property’s future value, which is crucial in determining the loan amount.  

Monitoring the Construction Process:

Lenders will monitor the progress of the construction. This monitoring ensures that the project proceeds as planned and that the funds are used appropriately.   Understanding the aspects of a commercial construction loan is vital for anyone considering a major construction project. It’s not just about getting the funds; it’s about effectively planning and managing your project from start to finish.  

Building Your Future with Confidence:

At Peoples Bank & Trust, we understand the complexities of construction financing. Our dedicated team is here to guide you through every step, ensuring your construction project is backed by solid financial support. With a focus on personalized service and in-depth industry knowledge, we’re ready to help bring your vision to life. To explore our construction loan options and how they can work for your project, call us today at (770) 932-1900.