Understanding Construction Loans

September 13, 2022

When it comes to buying the perfect home, many struggle to find one that meets their unique needs. If you’re having difficulty finding a property that checks all your homebuying boxes, a construction loan could provide the financial foundation you need to build your own or drastically modify an existing one.

Unlike home equity loans and lines of credit, which can be used for construction/home improvements and allow you to borrow against the equity you have on an existing home (meaning the difference between the current value of the home and what you owe on your mortgage), construction loans are not backed by your home or the money you’ve paid toward it.

While construction loans are a good option for many who are interested in building a custom home, they can be slightly confusing and require borrowers to closely follow an extensive list of lender requirements from start to finish. If you’re considering a construction loan, here are some other things to keep in mind:

• Construction loans only cover the short-term costs of constructing or remodeling a house and are usually just for 12-18 months.
• They can be used to buy land, draft plans, take out permits, and pay for labor and materials.
• Funds are paid out in a series of installments, known as "draws," while the home is being built. Your lender will determine the draw schedule based on your project plan.
• There are a few types of construction loans. They are:
  • Construction-to-permanent loans. Offered by BayFirst and also called single-closed loans, these loans require interest-only payments during construction and automatically convert into a fixed-rate mortgage once the home is completed.
  • Construction-only loans. These are adjustable-rate loans that must be paid in full or refinanced into a 15- or 30-year mortgage once the build is complete and require two application processes and two closings. These are not currently offered by BayFirst
  • Renovation loans. These cover over the cost of purchasing a home and performing major renovations, and loan amounts are based on the projected value of the home after renovations. These are not currently offered by BayFirst.
• Like interest rates for other types of loans, rates on construction loans generally vary based on the borrower’s creditworthiness, the size of the loan and the loan term.
• Common construction loan requirements include:
  • A solid credit score.
  • A down payment comparable to traditional mortgages or requiring private mortgage insurance for smaller down payments. However, with a construction-to-perm loan, borrowers will not pay mortgage insurance until construction is complete and they switch to their permanent mortgage.
  • A low debt-to-income ratio and income/assets that prove your ability to repay the loan.
  • Construction plans and specs. Your lender will need blueprints, plans that are certified as meeting all building codes, sign-off from a home appraiser and more.
  • A reputable contractor. Lenders will need to approve of your builder, your contract, and the budget and cashflow they’ve projected for the project.

If you’re wondering if a construction-to-perm loan is the right choice to help you build the home of your dreams, contact us today to learn more. If you’re ready to lay the groundwork for your home build with a construction loan from BayFirst, our expert lenders are standing by to customize a loan for your custom build. Get started by filling out the form below.