Understanding the Process
Once all of the "extra" documents have been collected, a borrower still has to meet basic loan criteria including loan to value ratios, debt to income ratios, and credit criteria. Borrowers are still required to fill out the standard loan documents including Form 1003, credit authorizations, tax returns and paychecks.
Construction loans are unique in the way that they are paid to the buyer. Rather than funding a loan all at one time, these types of loans work more like a line of credit. The loans are drawn down in pieces as various milestones are completed and reported to the lender. This involves the new homeowner working with the builder to gather the payment information. Lenders typically require supporting documents before they release the funds, which would be sent directly to the builder.
After construction is complete
Once the construction on the property is complete, a homeowner generally needs to transfer to a standard mortgage. Some construction loan contracts include an automatic rollover to a standard fixed rate mortgage. In other cases, the new homeowner may need a bridge loan to fill in the gaps between when the construction loan ends and the new mortgage begins.
Making the transition
When transitioning from these temporary loans to a permanent loan, the homeowner needs to requalify for a mortgage. This involves the same process as any standard mortgage. This means a property appraisal, new tax returns, new mortgage application and all other needed documents are provided to the new lender.
There are some items that are unique to construction loans that consumers need to be aware of. These include:
Most are adjustable rate - Unlike standard mortgages, the rates on construction loans are typically adjustable and are tied to prime rate.
Most are designed for short-term - Most of these loans are short-term and based on the time that it will take to construct the property.
Insurance required - Most lenders require that the homeowner and the builder have insurance. The builder needs to certify that they have a bond (insurance) for completion while the homeowner may be required to have insurance that "expands" as the property is developed.
When considering a construction loan, it is prudent to get a pre-approval for both the construction loan and the end finding. This helps a homeowner avoid unneeded fees. The contracts should be read carefully to understand the limitations of these types of loans and to understand how the loan will be paid, what the repayment plan involves and any information that may adversely impact the homeowner.