What to Know Before Applying for a Construction Loan

There are plenty of reasons to consider building a new home instead of buying existing real estate. Not only is the property more customizable, but you can end up with a valuable property that far exceeds the amount it cost to build it. Plus, the home will be brand new! Meaning you won’t be dealing with the surprises that may come with old or dilapidated properties. Of course if you’re new to real estate investing, or it’s your first time building new property, you’ll want to be well informed of the new construction loan process to avoid any snags that might delay your project. To help you get up to speed, here’s a few things to know before you apply for a construction loan.

What is a construction loan?

First off, let’s go over what a construction loan is in detail. These are short-term, higher-interest loans that can be used to cover the cost of land, contractor labor, building materials, permits, and more. There are a few types of construction loans, with the most common being construction-to-permanent, construction-only, and renovation loans. Construction-to-permanent loans have the ability to transition to a long-term mortgage, and are useful if you plan to rent out the property afterwards. Construction-only and renovation loans are, as the name suggest, only for construction or renovation. Finally, there are FHA 203k and owner-builder loans which have more specific requirements.

Loan terms and rates

Most construction loans are issued over a period of 12-18 months, depending on the completion of the project. Lenders may be willing to work with you to adjust or extend the length of a loan, but you should stick to a schedule to avoid any extension fees. Interest rates typically fall in the 7-9% range due to the short-term nature of the loan. However, most construction loans will only require you make interest payments until the end of the loan’s term, at which point you’ll pay back the full principal amount. Of course, every lender will have different terms and rates, so you’ll want to go over them in detail with your chosen lender beforehand.

Qualifying for a construction loan

Construction loans can be viewed as risky for a lender since they have no property to back them as collateral like traditional home loans do. It’s also part of the reason why new construction loans have higher interest rates. Lenders will definitely look at your creditworthiness when applying, and may even ask for copies of your bank statements as well. This is because lenders want to see that you’re able to cover closing costs, down payments, and any other expenses that may arise during the construction process. As for the project itself, most lenders will set limits on the loan-to-ARV (after repair value) at around 75% as well as on the total LTC or Loan-to-Cost at around 90% to ensure the project will be profitable.

Timeline of the loan

Since lenders depend on the completion of the project for the borrower to repay the loan, they may have strict requirements for approving a construction loan. Many lenders require permits to be in place and plans to be approved before closing to ensure the project will stays on schedule. This means you’ll have to get specific details from your contractors about dates, materials, workers, and methods. This is likely for the best, since you would be subject to loan extension fees if you exceed the original loan’s timeline. A plan is also necessary since your lender won’t be paying your builder with a lump sum, but instead through a series of disbursements called “Draws”. Each payment will be for a different purpose, and will be distributed according to your plan’s timeline.

RCN Capital

RCN Capital lends to real estate professionals, commercial contractors, developers & small business owners across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors. If you’re looking to finance a new construction property, RCN Capital’s trusted team is ready to guide you every step of the way. Connect with us today to discuss your next real estate investment.