||Ask Dr. Don
Construction loan terms and
Dear Dr. Don,
Why is it so difficult to shop construction
loan information on the web? It seems that nobody posts current
rates or specific information on how the loan works.
Construction loans are story loans. That means that the
lender has to know the story behind the planned construction before
they're willing to loan you money. Because it's a story loan, it's
not going to be standardized like mortgage loans underwritten to
Freddie Mac or Fannie Mae guidelines.
That said, there are some common features to a construction
loan. Construction loans typically require interest-only payments
during construction and become due upon completion. Completion for
homeowners means that the house has its certificate of occupancy.
Construction loans are usually variable-rate loans
priced at a spread to the prime rate or some other short-term interest
rate. You, the contractor and the lender establish a draw schedule
based on stages of construction, and interest is charged on the
amount of money disbursed to date.
Another variable in construction loans is how much
of the project cost the lender is willing to lend. If you already
own the land outright, then that can be considered as equity on
the construction loan.
Many homeowners use construction-to-permanent financing
programs where the construction loan is converted to a mortgage
loan after the certificate of occupancy is issued. The advantage
is that you only have to have one application and one closing.
Depending on your view on interest rate trends, you
could also purchase a rate- lock agreement valid through the expected
completion of the construction. Just make sure you allow for the
inevitable construction delays.
A construction loan, unlike a mortgage, isn't meant
to be around for a long time. If you're taking out a $200,000 construction
loan for six months, and you pay an extra .5 percent on the loan,
it costs you an additional $250. (Assumes an average $100,000 loan
balance over a six-month construction period.)
You may be willing to pay a higher rate on the
construction loan if you're doing construction-to-permanent financing
and can get better mortgage terms or a longer, better rate lock
from that lender.
-- Posted: March 20, 2002