Construction loans are most commonly used by prospective owners to build their dream home or to build a new piece of commercial real estate. There are two types of construction loans, which are very different from each other: Commercial construction loans are typically very short, lasting just a few years, while custom homes are typically built with a loan that acts just like a mortgage.
The two types of loans also have very different requirements, though the process to obtain them is similar:
- Create a plan for building the property
- Obtain approval from a lender
- Find a builder
- Build the property
- Final appraisal and inspection
When asking for a construction loan, the most important question will be what the property is used for. If you want to build a commercial property, then a lender will require a detailed plan showing how you will you will repay the loan, such as a business outline or a plan for selling the property. If you want a dream house, then the lender will usually require that you have excellent credit, be capable of making a 20% down payment, and display a large regular annual income.
Because many construction projects wind up being cancelled or abandoned, lenders often require much higher collateral than for a normal loan. Lenders will also require a more in-depth examination of your personal finances and credit history. Still if you can meet the requirements, then you should be able to find a lender for a construction loan, even in light of the recent upheaval in the mortgage market.
It’s important to note that nearly all construction projects come in over budget. You should therefore plan ahead when deciding how much to ask for in a loan, considering potential pitfalls or additions you might eventually want. You should also be very cautious when selecting a builder. If, for instance, you ended up with a less-than-reputable builder, the final appraisal of your property could wind up being less than what you borrowed, meaning you will owe more than your new property is worth. In that situation, your lender will not be willing to cut you a break; you will still have to repay the full amount of the loan.
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