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Construction Loan Information

"There are three conventional ways to financing your new dream home, aside from having the builder carry the financing for you and you refinancing the loan into your own name upon completion, and they are a one-time close construction loan, a one-time close with a note modification, and a two-close construction loan."

Types of Construction Loans


Authors Website: http://www.locallender.net/

Spring is just around the corner and many people are beginning to gear up for the spring building season. New developments are breaking ground, the annual "Parade of Homes" is being planned, and the Sunday newspapers are being filled with the latest and greatest features for new homes. However, before you get the wheels in motion, this may be a good time to get yourself acquainted with the different types of construction financing that are available to you. There are three conventional ways to financing your new dream home, aside from having the builder carry the financing for you and you refinancing the loan into your own name upon completion, and they are a one-time close construction loan, a one-time close with a note modification, and a two-close construction loan. The next few paragraphs should give you a good idea of what's out there, and provide you with the knowledge to ask the right questions and stay on top of the game.

One-Time Close Construction Loan

A one-time close, also called an "all in one" construction loan, is a fairly simple way to go about building your home. This type of loan offers a single close, and a single rate for both the construction term and the end financing (we'll touch on the rate later). Typically, these loans allow for a maximum 12 month construction term, and may have penalties for going over. Once the loan is settled construction may begin. You'll be asked to pay either interest on the money that has been disbursed to the builder, or a regular mortgage payment. This varies from lender to lender so be sure and ask what your options are before you get to far along. The funds are released either by a draw schedule, or a generic punch list. A draw schedule calls for certain items to be completed before funds can be released to the builder. This is different than a punch list because the list allows greater flexibility because different items are sometimes completed at different times, depending on what materials are currently available to the builder. As your home nears completion, you'll need to consider your final rate. At the settlement, you may have been given the options to either lock or float your rate. If your rate has been locked, you may have the ability to float down for a cost, typically one percentage point of the loan amount. If you chose to float your rate, you'll need to contact the bank about agreeing on and securing the final note rate. Once your rate is decided upon, and your home is completed, your note will automatically convert to a 29 year mortgage. The loan will be 29 years because one year was used during the construction period.

Note Modification Construction Loan

The second option to finance your new home is a construction loan with a note modification. This loan looks a lot like the previous loan, but with a few unique features. The first difference to address is that there are often two separate rates. The first rate covers the construction term (often based on prime), and the second rate is the end loan rate. The construction rate is typically fixed during the construction term, and you'll be asked to pay interest on the amount that is disbursed based on that rate. As construction progresses, your payment will increase accordingly. The end loan rate can either be locked, or left to float with the market. That decision is up to you. When discussing the end loan there are a few important points to note. First and foremost, find out how long your rate will be locked for. Often times, the rate can be locked for as long as nine months, or as short as three months. Be sure and allow enough time to get your house completed, and build in a cushion should and unforeseen issues arise. The second point to note is whether or not there is a float down option, and what it will cost. If you decided to lock your rate and mortgage rates fall during construction, you need to make sure that you have the ability to reduce your rate without refinancing after your home is completed. Moving forward, now that we've decided our rate terms we can get to building. As I mentioned before, you'll be paying interest on the money that is disbursed throughout the construction term until your house is complete. Once your house is complete, it is time to modify your construction loan. Modification is simply the process of converting your construction loan into a permanent mortgage. While there may be costs associated with this, they won't be nearly as much as a second settlement. Typically, the costs that are incurred during modification are to establish your escrow accounts and pay for any outstanding interest or other fees that may have accumulated during construction.

Two-Time Close Construction Loan

The third, and final type of construction loan that I'll discuss is a two-time close construction loan. This loan is just as it sounds, there is one closing at the start of construction and a second closing to refinance the construction loan into a permanent mortgage. Upon closing on your construction loan you'll begin making interest only payments to the lender, and just as before these payments will increase as construction progresses. Once your home is completed, you'll need to refinance your construction loan into a permanent mortgage. The costs will be greater for this type of construction loan, but there is a little more flexibility that goes with it. Generally, you'll be able to get a lower rate on your permanent mortgage because you'll be working with a true refinance rate, not the rate based on a construction to perm loan. Another thought to take into consideration is that you won't be locked into an end loan amount. This is important to consider in case you have any cost over runs or upgrades.

So when you start looking at lots and pulling together plans as the summer approaches, I hope that this article has given you a better understanding of what options are available and a few of the important questions to ask. So whether you chose a one close, a one close with a modification, or a two close, make sure that you have all of your bases covered and plan for surprises.

Other questions to consider when speaking with your lender:

Type Of Loan Question
One close/modification

Do you have a house to sell? If so, can you reduce your end loan amount when you sell that house?
One close/modification What happens if my construction cost runs over my loan amount?
Two Close What happens if my end loan falls through and I can't get approved again?
One close/modification/two close Is there a builder approval process? If so, how long does it take?
One close/modification/two close Who are the draw checks made out and sent to?

Local Lender - please see authors site for more information.


Note: This article was submitted by a second party and the contents are subject to our disclaimer.

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