Construction Risk Mitigation Industry Leader Brian Mingham Looks at 3 Types of Home Construction Loans
For some people, finding an ideal home for sale in a great location is not just difficult, but it is virtually impossible — especially in highly-coveted neighborhoods where new listings are few and far between. And to make things even more distressing, these eager buyers do not have sufficient savings to cover the significant costs of building or renovating their dream dwelling. Fortunately, that is where home construction loans enter the picture and make the impossible, possible.
“Home construction loans are shorter-term, higher-interest loans that are used to cover the costs of building a new home, such as permits, contractors, framing, landscaping, and interior finishing,” commented Brian Mingham, the Founder and CEO of CFSI Loan Management, a leading nationwide construction risk mitigation firm. “However, items that can be removed from the home, such as furnishings, cannot be included in home construction loans.”
As noted by Brian Mingham, construction loans are typically for shorter terms — usually a year — and because lenders take on added risk, the interest rates are higher compared to secured loans that are backed by collateral. There are three main types of construction loans: construction-to-permanent, construction-only, and renovation construction. Each of these is briefly described below.
Construction-to-permanent loans provide borrowers with the funds they need to build their new home. Once construction is complete, the loan is automatically converted into a permanent mortgage (typically with a 15–30 year term) at either a fixed or adjustable rate.
“The primary advantage of construction-to-permanent loans is that borrowers only need to pay for one set of closing costs, which can result in significant savings,” commented Mingham, whose firm enables lenders to reduce construction loan risks for residential, commercial, and multi-family properties. “Borrowers also have the option of locking interest rates at closing, which could lead to further savings if rates ultimately trend upwards during and after construction.”
Construction-only loans provide borrowers with the funds they need to build their new home. Once construction is complete, borrowers must repay the loan in full. Since this amount will typically be in the hundreds of thousands or millions of dollars, borrowers without sufficient cash available (typically raised through the sale of their previous home) have the option of refinancing the loan into a conventional mortgage, or applying for a new loan (called an “end loan”) to cover the balance.
“In a construction-only loan, funds are allocated as construction is completed,” commented Brian Mingham. “As such, borrowers are only responsible for interest payments on the funds that have actually been borrowed, not on the total amount available. Also, borrowers with construction-online loans who ultimately need a conventional mortgage or end loan will need to find a lender and pay the required closing costs.”
Renovation Construction Loans
Renovation construction loans enable borrowers to purchase and upgrade an existing home, rather than build a new one from scratch. There are several government programs available, and the estimated cost of renovations are combined with the purchase price. Borrowers can also secure a permanent interest rate prior to renovations.
“Borrowers who want to rehab the home they currently live in, rather than buy and upgrade another home, also have the option of applying for a renovation construction loan,” commented Brian Mingham. “Also, in situations where a smaller amount of money is needed, some borrowers may find it cheaper, simpler and faster to tap into their home equity. However, it is unwise to use all available equity for a renovation. If there is a cost overrun, or if other unexpected expenses arise such as major car repairs or medical bills, then borrowers may be forced to use credit cards or other costly types of unsecured debt. It is vital to realistically plan ahead and have contingencies in place.”