People who want to renovate their homes or build their own homes may turn to a construction loan. Construction loans offer a way for homeowners to finance both the time and materials needed for home construction and improvement projects. These are short-term loans with comparatively a higher interest rate.
This blog post will cover the basics of how construction loans work and explain why they may or may not be right for you.
What is a Construction Loan?
A construction loan typically comes with a fixed interest rate, though you may be able to find an adjustable-rate option. Rates will vary depending on the institution, but borrowers should expect rates at an average rate of around 4.5%.
The loan duration for this type of loan is usually one year. The rates are higher than other types of lending because there is a greater risk for the lender. If you don’t complete the project and default on the mortgage, the bank could lose money on both your original loan amount as well as on any additional costs it may have incurred by trying to collect from you.
What do these loans cover?
Every home project is a bit different, but generally, the construction loan would pay for:
- Plans, fees, and permits
- Raw materials and labors
- Interest reserves (if the borrower doesn’t want to pay interest amount during the building process)
- Contingency reserves (if the project costs are more than they were estimated)
- Closing costs
Why Should You Consider a Construction Loan?
Build equity now
One of the advantages of borrowing for your home construction is that you can accumulate equity in your property by making payments equal to or greater than your loan amount. If you decide to refinance, you will see this asset value increase as you pay off principal and interest over time.
If you take a traditional mortgage instead, your equity will grow slower and more gradually. It could take years or longer to build up equity if you take out a conventional loan. Keep in mind that equity is the difference between the value of your home and your debt (including any outstanding construction loan).
Keep cash on hand for renovations
As many homeowners will tell you, home renovations can be costly. They can also derail even an organized homeowner from being able to meet their monthly financial obligations on time and as planned. The money that you would otherwise use for your monthly mortgage or rent payment is already accounted for with a construction loan because payments are often made directly towards principal and interest.
With a conventional mortgage, you must cover the renovations with money out of your savings or make other payments to cover your debt. With a construction loan, you have the cash on hand to pay for renovations while keeping your regular monthly housing payment in place.
If you’re looking for hard money construction loans, Insula Capital Group can help you. We are a private mortgage lender that offers construction loans, flip loan financing, business bridge loans, and other loans. Contact us today to learn more about our financing services.