While sometimes it is easier for real estate rental investors to buy RFOs or ready-for-occupancy properties, most still prefer to fix up the house or have it constructed from the ground up. With this concept, the real estate investor will be in control of the design direction of the home. You will also choose the building materials and oversee the construction. In effect, you get to personalize or customize your rentals according to your preferences. You can avail of home construction loans that cater to such real estate needs.
Home Construction Loans. What are they?
A construction loan is a short-term loan used to finance the building of a home or a real estate project. Home Construction Loans are the types of loans that will get you through a construction project if you lack some funds to finish it. The loan will provide you with the much-needed funds for house construction, renovation, or house rehabilitation. In this loan, your lender releases the funds on a staggered basis. The releases depend on the progress of the construction or renovation. In a bankrate.com article, construction loans can cover the following:
- Cost of Construction
- Contractor Labor
- Building Materials
- Cost of the Land
- Permits
Advantages of a Construction Loan
Diving into a construction project without thorough planning might see you looking for funding midway in the construction. With home construction loans, you will have a lot fewer things to think over.
- You will enjoy flexible terms that range from 6 months to a maximum of 18 months, depending on the timeline of your construction project.
- During the construction period, you only pay the interest for the loan. Furthermore, the interest payments depend on the amount of the released funds. So, for instance, after two months of construction, let us say the total funds released are $50,000.00, and with an interest rate of 10% per annum, the interest payment will amount to $417.00.
- Prevent spontaneous changes to the building plan during construction.
- Choose how to exit from the construction loan. You can transition to a Permanent Loan, for instance.
The Disadvantages of a Construction Loan
For every undertaking, there are also disadvantages that you need to know to make an informed decision.
- Your lender will require a lot of documents for the construction of your house. These documents detail the house construction.
- Monthly payments during construction are for interest only. Thus expect an increase in amortization after the project completion. In Construction to Permanent Loans, the loan amount spreads over the remaining term. Let us illustrate, a construction period of 12 months takes one year off of a 15-year Construction to Permanent Loan. Hence, you will only have 14 years for the principal payments, increasing the projected monthly installments.
- Construction Loans usually have higher rates than other mortgage loans because your lender tries to mitigate the risks they have to take in construction loans.
- Deciding to change the plan midway during construction necessitates changes in the budget and building materials acquisition. Such moves can lead to higher construction costs and a new round of talks with your lender.
- You will need to settle the construction loan in one way or another when it finishes in 6, 12, or 18 months.
Construction Loan Interest Rates
Construction Loan rates are typically higher than the rates of the usual mortgage loans. The higher loan rates mitigate the risks taken by the lenders to take a chance on the construction. Perchance the house construction fails, the lender will have to deal with an unfinished project that may not be easy to sell.
Construction Loan Requirements
Construction loans have additional requirements that you need to submit. Aside from regular mortgage loan requirements, you need to provide supplemental documents for these types of loans. First is the Building Plan, second will be the Scope of Works which specifies all the construction works for the contractor. The Bill of Materials, detailing the projected costs of all materials and labor, rounds them up.
Two Types of Home Construction Loans.
Construction to Permanent Loans
A CP loan is a viable loan alternative if you want to build a rental or renovate an investment property. They are also known as single close loans since you will only need one mortgage to proceed with your project as it covers the property acquisition, construction, and the long-term loan that will take over the construction loan. The rates in these loans are usually fixed and locked up for the whole term of the loan. As with other construction loans, you will pay only the interest payments during the construction phase, based on the tiered fund releases.
Owner-Builder Construction Loans
These are construction loans where the owner also acts as the builder. The owner-borrower must be a licensed builder or building contractor to qualify for these loans. One drawback in this loan scheme is that you have to convince the lender, beyond a reasonable doubt, that you are indeed qualified for the loan. Since the lender also gives you the funds directly as the owner-builder, there will be no check-and-balance in fund disbursement. Owner-Builder Construction Loans have higher interest rates than other types of loans. The lender will be extensive in verifying your expertise in the field.
So What is the Best Option for You?
Crystal clear is the option if you are not a licensed builder. Construction-to-Permanent Loans save you from a transition step between loans. Granted that your project is a rental, you will not have to apply again for another loan to pay off the construction loan when the time comes. You do not have to repeat the loan process and submit new documents when the construction has finished. CP Loans save you from the costs of another closing.
On the other hand, Owner Builder Construction Loans will prompt you to find funds for the loan exit. You can apply for a long-term mortgage, use your savings for the pay-off, or sell the property.
If you are looking for a lending partner in building an investment rental property, you may want to call us now because we will make it happen for you. Get in touch with us at info@gllholdings.com, or give us a call at (832) 770-9415. You may want to visit our website to know more about our loan products, or if you are around Houston, why don’t you drop by our office and have some coffee.
