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How Construction Loans Work

January 20, 2010
Construction loans are very different from the traditional mortgage which many are familiar with. This type of loan can be very confusing to someone who has never built a home before so clarifications need to be made. With a construction loan, you have two portions to consider. First there is the construction part of the loan. Once the home has been built then your loan will be transferred over to apermanent loan similar to what is seen with a home that is already built. The terms for each portion of a construction residential loan are very different. Let's explore those differences.

During the time that the home is being built, your loan will be operating under the construction portion. While working under this portion of a construction residential loan, you will only be charged interest on the funds that have actually been paid out. This is very helpful as you don't want to be paying interest on funds that are still sitting in a bank vault. You are not making a full payment on a house that you cannot live in. The construction period typically lasts for a period of twelve months, yet be sure to read your loan documents to know exactly what is stipulated. Once construction has been completed, the permanent part of your loan will begin. This portion of your construction residential loan is just like a traditional mortgage. You will begin making monthly mortgage payments at this time. The interest rate for your mortgage will depend on what you and the lender agreed upon before construction began.

Construction residential loans can be used in a variety of ways. You can choose to do this loan as a new purchase, a refinance, or a cash out refinance. These loans can be used for our primary residence, a secondary home and/or a rental property. There are often limitations on which types of dwellings you canuse a construction residential loan for. Apartments, condos and other structures are often excluded. Also, the length of the construction part of the loan needs to be reviewed as some construction loans can be as short as four months.

Be sure to ask about other restrictions on your construction residential loan. There may be contingency and special construction reserves as well as a limit on draw allowances. Interest rates and qualifying rates also need to be looked at. Yet don't let all of these distract your from your goal. Having the home of your dreams is well worth the effort involved.

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