How to Get a Construction Loan

A construction loan can be simply defined as a credit or loan to build a house or develop property. A construction is quite a complex transaction owing to the fact that its initial lending from the lender to borrower is different than usual loans and there are several complexities that are involved in the process of lending and repayment. Apart from the complexities, all lenders tend to follow different policies and terms and conditions while lending construction financing. Most of these complexities have been resolved into simplicity in the following paragraphs. A comprehensive input regarding the step by step process that can be used to get such a loan has also been included.

It must be noted that construction loan can be personal or commercial, the underwriting, lender assessment, approval and payment and repayment tend to differ quite a bit. The commercial construction loans are, in fact, more costly as compared to normal construction loans. The basic mechanisms and principles however, remain the same.

Basics of the Construction Loan

The construction loan as mentioned above, is provided to finance and fund the total prime cost and overheads of the construction project. Here are the quick basic features of such loans:

1. A construction loan is usually provided in installments, that is in 'draws'. A single draw is a small payment of the portion of the loan by the lender to the borrower. This primarily works on the lines of a common Home Equity Line of Credit (HELOC).
2. Secondly, a majority of the construction loans are secured and a portion of the home equity is pledged as the collateral.
3. Thirdly, the interest rate or APR is not levied at a fixed and flat rate and is usually made on the basis of the draws.
4. The repayment of the construction loan is on a very different basis and is undertaken through which is known as an 'interest reserve'. The reserve is a locked account of periodic payments where the borrower keeps on pooling the money and total gets transferred to the lender on a stipulated date. The reserve is often filled up with wage garnishment, and when no money enters the reserve, a restriction is imposed on the draw. The initial reserve amount is usually small and is only contributed into the reserve to see through the transaction of the loan. As a result of this concept of draw and interest reserve, in several cases, the actual interest rate (in %) is a bit lower than the usual.
5. The lenders, in addition, never approve a loan whose principle is equivalent to the total cost of construction. Commonly, lenders approve about 80% to 90% of the total construction cost.
6. The approval process of this loan, which also consists of the underwriting of the loan is also a bit different. While underwriting such a loan, the lender tries to calculate the probable loss that he might incur. In such a case, to form a safety net there are two things that would come into picture, firstly, the income of the borrow plus the income from property and secondly, worth of the property and its equity upon completion.

These differences from the usual procedure often tend to make the loan's approval also a bit different. The steps that you would have to take up while actually applying for this loan are also different. You will have to take up considerable planning, just to get the loan. Here's how you can go about it.

Steps to Get a Construction Loan

The first and also the universally applicable step in getting a construction loan is research. Making yourself aware of the market, common conditions, mechanisms and procedures is an absolute necessity. As mentioned above, due to the extreme complexity of the loan, there several differences that are observed in the mechanisms. Differences may exist in draws, interest reserves, nature of the interest rate, etc. Hence constant research is required, and updated knowledge thus becomes a necessity. Here are is a very quick elaboration on the steps that you can initiate to get a good construction loan...

• A pre-qualification is of a high priority, if you want to get a construction loan. To get a pre-qualification for a construction loan, you will need one steady source of income, a plot of land that has a reasonable projection and that will yield good market prices in the upcoming years, costing of the entire project and lastly a good equity.
• The second thing that you will need to take care of is fixing up the actual principle amount of the loan, which as mentioned above is not always given in full, then you will need to consider the rate of interest which can be both fixed and floating. Next off, you will also need to make provisions for the interest reserves, as once you actually start off constructing, you will be drained off cash.
• Third step is extremely crucial and it involves working with your lender, to get the best possible project plan, a high projected equity and a good market price on the finished project. This makes underwriting the loan quite easy and is also beneficial for both the parties, as lenders want back their money and the land owners want good equity.
• After all these steps are done, then comes the actual appointment of contractors. This actually proves to be really easy and the pre-qualification procedure tends to act like an upper limit budget in the construction cost. Also note and remember that you have to bear a certain cost on your own.
• This completes that planning and finalization after which the actual loan is granted and the draws begin. The draws, often directly correspond to the first costs. The second draw also corresponds to the related costs incurred at that said point of time.
• The last thing that you would need to take care of is get some insurance such as property insurance and a general liability insurance.

This procedure is also applicable, in exact, to the commercial construction loans. The only difference is that during the underwriting stage the realization value of the property is more relied on for loan approval.