Construction
loan is a special loan that is drawn by people to fulfil the resource
crunch that house construction activity is normally associated with. A
construction loan comes with certain features that are distinct from
the other regular loans. First, it is a short-term loan. Second, there
are no fixed set of rules to define its terms.
Construction of your house is going on at a normal pace when the
depleting finances threaten to disrupt the process. The derailment in
the construction activity will significantly increase the cost of
construction. If arranging finance within such a short notice is
turning out to be a difficult proposition for you, then a construction
loan will be helpful.
Construction loan is a short-term loan unlike mortgages and home loans
that have a protracted repayment. The loan provider in this case will
offer the loan until the borrower regains the occupancy rights to the
home. This means that as soon as the borrower completes construction
and makes the home as a primary residence or a second home, the loan is
due for repayment.
There are no standardized guidelines to state the terms of the
construction loan as in case of mortgages, which are governed by the
rules made in Financial Standards Association (FSA). Depending on the
individual case specifications and the degree of consideration that a
borrower receives from the lender, a borrower may be able to get
construction loans at differing terms.
The rate of interest for instance will be derived depending on the
stage at which the construction is, and with all parties to the
agreement, i.e. lender, borrower, and contractor (if any) consenting to
the rate found. Since it is a short-term loan, construction loan
borrowers must be prepared to shell out a greater amount as the rate of
interest. Mostly the rate of interest is charged on the basis of
adjustable/ variable rates.
Another distinguishing feature of construction loan is that it is
generally repayable through small interest-only repayments. This makes
them more convenient for borrowers since the repayable instalment
further lessens. However, this may be taxing for people who will find
it difficult to arrange the entire amount immediately after completing
the construction of home, which in itself is an expensive affair.
For long-term financing needs, the construction loan has to be
converted into a permanent loan known as a take-out loan. The
conversion gives additional finance to the borrower along with an
extended term of repayment. Till the borrower finishes construction, it
is a construction loan. As soon as the construction is over, the loan
is converted into a mortgage.
However, this has its drawbacks. Borrower is locked in the deal at the
terms of the lenders. The options available are limited. Either accept
the terms of the lender or make an immediate repayment. And a majority
of the borrowers go for the former, i.e. accept the deal being offered
by the loan provider.
Rate lock is an important method by which borrowers can escape the
vagaries of the interest rate. The method of rate lock does not allow
the rate of interest from rising beyond a certain level. The number of
days that the borrower wants the rate lock to be in effect will decide
its price. Rate locks are typically for a period ranging from 30 to 60
days. Rate locks become a limitation when the rate outside fall further.
In construction loans, as in case of mortgages and secured loans, home
is in equal danger of being repossessed for non-payment of the amount
due. As per the rule, the borrower has to put his primary residence as
collateral. Expert advice thus holds a place of prominence in the
process of decision-making. There are a number of sources from where
advice may be had easily. These include an attorney, certified public
accountant, or realtor unrelated with the loan providing organisation.
Individual prudence also needs to be applied because it is the
individual who is better aware of his financial circumstances and thus
the best decision maker.
