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What is a construction loan?

Aug 4, 2022 Bank Speak

Dreaming of building your custom home, but don’t know where to start? The building process is already stressful enough without having to think about the type of loan you need or how to manage the complex construction process and withdrawal schedule. BankSouth is here to answer your questions and help simplify the entire process.

1. What is a construction loan?

A construction loan is a short-term loan to finance the building of a new home or remodeling of an existing home. Similarly, a renovation loan is to finance the remodeling of an existing home. We’ll refer to both construction and renovation loans as “construction loans” in this article. The funds from a BankSouth construction loan are deposited into a construction checking account for the borrower to pay their contractors or builder at different phases of the custom home construction project; this is also called a “draw schedule”. It is also not uncommon for an inspector to be sent to the construction site before each draw is deposited into the construction checking account to verify the progress being made to your new home.

2. What is the difference between a construction loan and a mortgage?

A construction loan is the first type of loan you might acquire when building a house. It is set up with multiple withdrawals, and you only pay interest each month on the amount of the loan already dispensed to you.

Mortgages are set up as installment loans for a fixed period and can only be made once your home construction is complete, or if you purchase an existing home. Because construction loans require a higher level of management than a mortgage, they usually have higher interest rates and down payments. Consult with a lending expert to confirm current rates and down payment requirements for construction loans in Georgia.

3. How much money do I need to put down?

Most banks generally require borrowers to invest 20% equity into their new home.  

This can be calculated by adding up your total home cost, including the land. Total project cost is best calculated by adding your lot value/price + cost to build. For example, if you paid $100,000 for your land, and your construction budget is $300,000, your total project cost is $400,000, so you would need to invest $80,000 total into your project. This can be paid upfront in the lot if you paid cash, or it can be done in two steps, 20% down on the land ($20,000) and you would bring another $60,000 when you start construction. 

4. Do I have to sell my current home before I build to access the equity in my house?

Not necessarily! You can pull out equity from your current home on either your lot loan or your construction loan, so you only have to move once! This is sometimes referred to as a “bridge loan”.

5. Which should I consider first: my construction loan lender or builder/contractor?

This can depend on where you are in the process. Some people want financing pre-approval so they know how much they can afford when building their new home. Others have a contractor and detailed building plans before they start the process to obtain a construction loan. It is important to check with your financial institution because some banks require building plans before they will approve a construction loan. Our home financing team members are experts in construction loans and are always willing to lend a helping hand.

6. What is the construction loan process?

A construction loan is used to build or renovate a primary or secondary residence, purchase a lot or land for your home to be built on, or buy a lot with a pre-existing structure and tear it down and start over from scratch. To make this happen, BankSouth offers a two-closing construction loan process for our borrowers. The first closing is meant to establish the financing for the construction loan, and the second closing is to roll the construction loan into a permanent mortgage. BankSouth opts to offer our customers two closings on construction loans for flexibility; if the construction costs go over or come in under the construction loan amount, the permanent loan can be restructured as long as the costs are within your approved conditions. This process is also called a construction-to-permanent loan.

To summarize the construction loan process: 

Step 1: Construction Loan Application

Step 2: Construction Loan Closing

Step 3: Construction Begins

Step 4: Construction Completes

Step 5: Close on Permanent Mortgage 

 

7. What is repaid during the construction period?

You are only required to make interest-only payments during the life of the construction loan, and interest is only due on the amount of the construction loan withdrawals. Principal plus the interest on your mortgage gets repaid during the life of the mortgage, which is typically 15 or 30 years. The principal is the amount of money you borrow from the bank, and interest is the fee you pay for having the loan. 

8. How long does a construction loan last?

Construction loans typically last for 12 months but can be extended for a longer term if necessary. Even if the physical construction lasts less than 12 months, your construction loan still lasts the full period. This is beneficial for many people selling their previous home as it gives them time to sell before making full mortgage payments on their new residence.   

9. How do I manage my building process?

Once you have your construction loan and building plans, it’s time to get started building your dream house! You may be wondering how you will manage your building process. The construction management process for your home can vary across financial institutions. Many Georgia construction loan lenders offer visibility during construction or a way for their customers to manage the construction of their new home. This can be in the form of continuous communication throughout the process with the lender and building contractors or the use of technology, or a mix of both.

At BankSouth, we use a mix of both. We have skilled members on our team and cutting-edge technology called BankLabs to keep you organized and informed as you move through the home building process. BankLabs keeps your project rolling and provides you access to monitor every step from inspections to when a new draw is available from your construction loan. You are kept up to date throughout the process when you choose BankSouth as your construction loan lender.

To learn more about construction loans and how we can help you build the home of your dreams, read more on our website here. 

Is there a question we didn’t answer?

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