If you are an ambitious real estate investor you might be considering taking on a new construction project. However, construction is as expensive as buying a house. With the help of ground up or new home construction loans, you can cover the costs of land, labor, and material used to build a new house from the ground up.
There are several types of construction loans to choose from apart from traditional mortgages. This article will discuss how new construction loans work and what you need to qualify.
Definition of a Construction Loan
Construction loans are short-term financing used to cover the expenses associated with building a house from beginning to end. Construction loans cover several factors, including the drafting plan, the cost of buying land, paying for labor and materials, and taking out permits.
Construction loans can also help you to access contingency reserves, especially in cases where you have a project more expensive than you planned.
How New Construction Loans Work
For real estate investors, construction loans are necessary to help you pay for the labor and purchase every material needed to build a home. Often, you can decide to use the money to purchase the land you want to build on.
However, if you own land already, the purchase price for land acquisition and construction costs will be factored into calculating the total loan amount. In most cases, at closing, a partial amount of the land cost can be made available to borrowers. These funds can buy the initial supply of materials or put towards acquiring the land for the next project.
Compared to traditional mortgages, you can't secure construction loans using a completed house. Here your lender will likely want to inspect your architectural plans and examine your financial situation before you get approved for financing. You also need to provide an estimated construction budget and timeline.
Typically, since construction loans are designed to cover the construction period, they have a 12 to 18 month term. In case you need more time to complete the project or face supply shortages, you can either get an extension on your original construction loan or replace it with a bridge loan.
Although all your application for a construction loan has been approved, you will not receive all the money you need as a lump sum. However, the lender will disburse funds to your builder using a series of installments, or draws, as different stages of construction are completed.
Once you, the borrower, requests a draw, an inspector visits the property to evaluate the construction status. Upon review of the inspection report, the lender releases each payment.
At Alpha Tech Lending we always provide funds for 100% of the construction budget. Compared with other conventional loans, our new construction (as well as fix and flip) interest uses Non-Dutch calculation. Non-Dutch means interest is calculated on the portion of the construction budget disbursed NOT the entire holdback amount.
Tips to Help You Get a Construction Loan
Before getting any money to start your construction project, you need to be approved for financing.
Here are tips to guide you toward your construction loan approval.
1. Have an Excellent Credit Score
Having an excellent credit score is important before taking on a new construction project. Most lenders require a minimum credit score. The higher your credit score is, the more leverage you have as a borrower.
In preparation of building a house, take time to look for ways to improve your credit score prior to applying for a construction loan. This allows you to qualify for the highest loan amount for your project.
2. Have a Down Payment of at Least 20% on hand
As a borrower, it is important that you make at least a 20% down payment before you take it as a construction loan. You should have enough funds of your own to cover the down payment AND also closing costs.
3. Get Builders Risk Insurance
Builder’s risk Insurance or course of construction insurance is a type of property insurance specifically for buildings under construction. Having a properly structured builder’s risk insurance policy is crucial and will show lenders you have taken risk management into consideration. It’s important to know that a standard insurance policy will not include builders' risk and not every carrier offers this type of insurance.
Builders risk insurance can protect against fire, lightning, hail, explosions, theft, vandalism, acts of God.
4. Prepare Your Construction Project Budget
Due to the fact that there are a lot of moving parts involved in building a house, lenders will need to see every available detail regarding the proposed budget. To help you plan your budget you can always take a look at our downloadable forms page and download the budget form. This excel sheet will help you plan the costs of each stage of the construction project.
Conclusion
As an experienced real estate investor, you need a construction loan to help you upgrade your home or completely build a new one from scratch. With the above-mentioned, the process will be easier for you.
Alpha Tech Lending has been an active lender in the new construction space since 2007 and our team has deep knowledge of how to structure and finance these deals. Get in touch with us today!