A property construction loan is different from other types of loan. The most likely reason for looking for a property construction loan is to build a house or commercial building from nothing. If you are seeking to extend your existing property, you should see if you can refinance your current mortgage, rather than looking for a construction loan.
Why? The process of obtaining – and servicing – a property construction loan probably involves more traps and pitfalls than any other type of loan. You need to be very sure what you are taking on, and do your homework thoroughly, before rushing into anything.
So here are some of the things you should be making sure of if you are going for a construction loan.
- Get pre-qualified for the loan before doing anything else – i.e. before you even get the land. This will help you to be clear what your budget will be – and to know whether you can actually afford the project in the first place!
- Looking round for the right lender can be a headache. Just about any lender will be delighted to offer you a property construction loan, but that doesn’t mean you should take the first one that comes up. One way to go is to find an experienced broker who specializes in construction loans. A good broker will be able to provide useful advice as well as finding the loan that is right for your needs.
- Up till recently the only type of construction loan you could get was a six-month or twelve-month short-term loan, which had to be refinanced into a mortgage at the end of the term. This of course meant two lots of pre-qualifying, two lots of closing costs etc. Don’t believe any lender nowadays who tells you that this is all you can get. The ideal loan you want to look for is a one-time-close, construction-to-permanent loan, that allows you to lock in a low interest rate up-front. (Avoid the lenders who impose a higher rate if you lock-in up front.)
- Once you have identified a possible lender, check out the level of experience of the loans officer, or whatever the individual who deals with you is called. An experienced loans officer is one of the most important criteria for choosing a lender. Remember that the loans officer is paid to get you through the loans process as quickly as possible, so that they can get on to the next borrower, so an inexperienced person can make mistakes which can cost you dearly. Keep your eyes open at every stage of the process. For instance, watch out that the loans officer locks in your rate correctly – doing this wrong is a common mistake.
- Always get your full quote in writing and scrutinize it carefully to make sure it is the same as the deal you were originally promised. It is not uncommon for a lender to try to palm you off with less good terms than advertised.
- Construction projects are notorious for going over time and over budget. Ask if there is a possibility of including a contingency reserve as part of your loan. A contingency reserve may be attached to your loan either as a Builder’s Coningency or as a Borrower’s Contingency. The Builder’s Contingency will allow the builder to draw from the fund for cost overruns etc.
- You will need to get a detailed breakdown of the building costs, to be submitted early in the process. Also the lender will probably want a resume or outline of the builder’s experience, and may also do a credit check on the builder to be sure they pay their bills.
- To be able to predict the viability of a project, you need a good knowledge of the area – transport, schools, medical provision etc. The lender will need this information so do your research before you start.
- A property construction loan needs three separate approvals – yourself, the project and the builder – so usually takes longer than an ordinary loan. Allow up to six weeks.
- Finally, you need to make sure you keep control of the project – i..e. make sure the loan is for yourself not for the builder. The last thing you want is to find a few weeks after the project is finished that one of the subcontractors hasn’t been paid and is placing a lien on the house, preventing title from being transferred. The subcontractor can sue and foreclose, to recover unpaid goods and services.
As you see, getting a construction loan can be a potential minefield! However by following these tips you should be able to sidestep most of the pitfalls and ensure success in your project.