Basics of Construction Loans

In recent years, the costs associated with buying a home have skyrocketed. So, if you’re in the market for a new home, you may be considering building a home- instead. As part of building your own home, learning about construction loans, how they work, and if one is right for you should be part of your process.

Building a home isn’t necessarily cheaper than buying a home, but it could offer you better options for a home that fits your budget, needs, and lifestyle. There are loan options that are specifically intended to be used for all of the costs associated with building a home. Arkansas Federal Credit Union offers construction loans with competitive rates. You can apply easily online. Call one of our local branches or apply online today to get pre-qualified and learn more about how a construction loan may work for you. 

What is a Construction Loan?

A construction loan is a short-term loan that is intended to cover the cost of building a home. Construction loans are usually a year long and typically have more stringent requirements, such as a higher credit score and a lower debt-to-income ratio  than other types of home loans because they are considered to be riskier for lenders. 

While your home is being built, you will usually only pay interest on your construction loan. After your home is built, you will need a mortgage to purchase the completed home. A construction loan only finances the construction of the home and not the purchase, which is an important defining characteristic of construction loans. But at Arkansas Federal, we will provide you with an initial construction loan and once the construction is complete, we can help you apply for a regular mortgage loan. 

How Do Construction Loans Work?

A construction home loan covers the total cost associated with building a home, from purchasing and clearing the land to paying workers for their service. 

The approval process for a construction loan is similar to a traditional mortgage, but again, the requirements may be a bit more stringent than with a regular mortgage. In order to get approved, you will need to apply and submit documentation. After you’re approved, you can start accessing the funds for construction. 

Construction loans typically only allow you to access a certain amount of funds at a time. As you progress through phases of construction, you will be able to access different amounts of funds and will then make a monthly payment for the amount of interest on those funds you’ve used. Throughout the construction process, it’s common for an appraiser to check on the build. The appraiser’s job is to make sure that your build is on track so you can continue to have access to your funds. This is a major difference between construction loans and traditional mortgages. With a typical mortgage, there is a lump sum payment to purchase the home rather than payments in stages.

When Should You Get a Construction Loan?

Before getting a construction loan, it’s important to make sure that you’re as prepared as possible. It’s a good idea to get rid of any debt or credit issues before applying for a construction loan.

Typically, you’ll need a construction plan before getting approved for a construction loan. You need to have the budget, plans, and detailed specifications of the project determined before you apply for your construction loan.

Construction loans can take some time. It’s a good idea to give yourself time from when you apply for your loan before you hope to start construction. You should give yourself about 30 days from when you finish your plan and budgeting to get the appraisal before your construction loan gets approved.

Construction Loan Requirements

Home construction loans are typically considered riskier for lenders, which means that there can be stricter requirements to get a construction loan over other types of loans. In order to qualify for a construction loan, you should have a high credit score and a good debt-to-income ratio, which is the ratio of your monthly recurring debt to your gross monthly income. You should also have saved a down payment of about 20% of the total cost. If you already own the land, you can use the equity in your land as the downpayment instead.

As part of your approval process, your lender will likely want to approve the builder you’ve chosen and make sure that they’re certified and insured. This helps protect your lender’s money but also helps protect you by making sure that your home is being built by a builder who is reputable and trustworthy. 

Your lender will also want to look over your plan for construction so they can approve it and make sure construction is staying on track throughout the build. Creating a construction plan helps ensure that everyone involved in the construction process knows the project’s expected timeline and that you will be informed if there are any delays or changes to the expected construction plan. 

Pros and Cons of Construction Loans

As with any type of loan, construction loans have advantages and disadvantages. Depending on the details of your specific circumstances, a construction loan may or may not be the best loan option for you at the moment. 

Pros

Construction loans typically start with a 12 month term so that you can have a bit of wiggle room to adjust for weather, supply, or other delays. However, if you need to adjust it, it’s easy to do. This is helpful because if there are unexpected delays that are out of your and your builder’s control.

Lenders usually give guidelines with construction loans as part of the construction plan. While this may be an extra step you have to take in order to get approved, following these guidelines can help you make sure that your project stays on budget and on schedule.

Cons

Because they are considered to be riskier by lenders and are unsecured until the home is built, construction loans sometimes have higher interest rates than other types of loans. Arkansas Federal offers construction loans with competitive, fixed interest rates. 

The risk associated with construction loans also means that they can be more difficult to qualify for. A construction loan may require you to meet higher standards in order to qualify than other loan types.  

Apply for a Construction Loan Today

A construction loan can be a great financing option for someone who is looking to build a home. Using a loan intended for construction can help your construction stay on track and help you stay on top of all costs related to building your home. 

Arkansas Federal offers fixed-rate construction loans with competitive interest rates. You can use our free mortgage calculator to get an estimate of your mortgage payments.
 
– There’s no cost to apply. You can apply online today to lock in your interest rate for up to 90 days. If you have other questions about construction loans, you can call us at 800-456-3000 or visit one of our local branch offices today.