How Do Building Loans Work?

by HomeLoan.com
Building loans, also known as construction loans, are designed to finance the construction of a home or building. They are based on a building budget, and funds are disbursed in percentages of completed construction. A construction loan is temporary, and must be paid off with a permanent loan. (For a future homeowner, a construction loan can be a "construction-perm," which becomes a permanent loan at the end of construction phase without a second closing.) When applying for a building loan, you must supply a cost analysis (cost to produce the home), blueprints, a contract for the lot (or deed if you own the lot), a draw schedule (payments from the construction budget expressed in percentages of completed construction) and your financials. A construction-perm loan requires builder approval. The bank orders the appraisal, finalizes the process and approves or rejects the loan. If approved, the closing is scheduled with an agent who conducts a title search, orders a survey and waits for closing instructions from the funding bank.

Obtaining a Building Loan

Building loans, also known as construction loans, are designed to finance the construction of a home or building. They are based on a building budget, and funds are disbursed in percentages of completed construction. A construction loan is temporary, and must be paid off with a permanent loan. (For a future homeowner, a construction loan can be a "construction-perm," which becomes a permanent loan at the end of construction phase without a second closing.) When applying for a building loan, you must supply a cost analysis (cost to produce the home), blueprints, a contract for the lot (or deed if you own the lot), a draw schedule (payments from the construction budget expressed in percentages of completed construction) and your financials. A construction-perm loan requires builder approval. The bank orders the appraisal, finalizes the process and approves or rejects the loan. If approved, the closing is scheduled with an agent who conducts a title search, orders a survey and waits for closing instructions from the funding bank.

Closing

At closing, there can be a draw (money paid out) against the construction budget to pay off the lot. If you are the future homeowner and own this lot already, its value will be credited against the bank's down payment requirement. Usually, the closing costs are taken from the budget (loan amount), and the builder or homeowner is sometimes allowed to receive 10 percent of the building budget for start-up building costs.

Construction and Draws

When construction begins, a draw of funds is needed to pay suppliers and labor, so a request is made to the bank. The bank sends out an inspector to do a visual check making sure work has progressed. Each supplier also may be required to supply an affidavit showing work progression or supplies along with a bill for outstanding funds owed up to the time of the draw. If the bank is satisfied, the draw is approved, and the work continues. This process continues according to the draw schedule that was approved by the bank. When the home is about 60 days from completion, the homeowner should begin the refinance process to pay off the construction loan. If the construction loan is a construction-perm loan, this is not necessary.

Completion

While the home is under construction, monthly interest is due, based on the balance of the loan and the interest rate set by the bank. When the home is completed, the county agent conducts a final inspection and issues a certificate of occupancy, and a final inspection is done by the homeowner's appraiser. Once this is done, the loan comes due; if the loan is a construction-perm, a modification package will be sent out to the borrower for signatures. If the home is being built by a builder, and the home has not been sold, interest will be due every month until the home is sold and the construction loan is paid off.


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