Construction Loans in St. Louis, MO
By Ryan Cox - Senior Renovation Loan Specialist
If you are considering building your dream home instead of buying an existing home on the market, it could surprise you to learn that you will not be getting a traditional mortgage. Alternatively, you’ll likely be getting a construction loan. For your benefit, I have put together some information to help you learn what construction loans are, how they work, as well as the pros and cons of using them to finance your dream home.
What are Construction Loans?
Construction Loans are higher-interest, shorter-term loans that are used to cover the cost of building or rehabilitating your home. Unlike a traditional home loan, which is based on the fair market value of the home and determined by the home’s condition in comparison to other recent sales, construction loans are based on what the projected value of the home will be once the work has been completed.
There are a few different types of construction loans that you can choose from:
- Construction-to-permanent loans: These loans work well if you have definite construction plans and all your timelines in place. In this case, the bank will pay the builder as the work is being completed. Then, that cost will be converted to a mortgage at closing. This type of loan will allow you to lock in your interest rate at closing.
- Construction-only loans: A construction-only loan must be paid off in full once the building process has been completed. This could be a good choice if you have a large sum of money to work with, or you are confident that the proceeds from the sale of your current home will cover the cost of the new build. In this case, if you need a mortgage to cover the cost, you will have to search for the lender yourself and also be approved another time.
- Renovation loans: These types of loans can be used if you are considering buying a fixer-upper or a property that needs a lot of work. In this case, there are several different products that can be used to incorporate the projected costs for all renovations you plan on doing to the property, along with the purchase price, then everything is wrapped up in a mortgage. There will be one loan, one closing & one payment.
How construction loans work
Traditional loans are paid out by a mortgage company to cover the cost of the home in one lump-sum at closing. With a construction loan, payments are made in installments. A bank will pay the builder as different phases of the building process have been completed. The total cost is transferred to you once the entire project has been completed. These installments are called draws. Each draw will reimburse the builder for the costs needed to cover that phase of construction. Before each draw can be made, the bank will do an inspection to verify the estimated cost of that phase and to make sure all of the work listed has been completed. Since the financing of a construction loan has many variables, it is crucial to work with a good builder. You will want someone that is experienced in budgeting, scheduling and has the ability to work well with everyone involved in the process.
What are some benefits of a construction loan?
- They are interest-only during construction: Since the loan isn’t paid out in full until all of the construction is complete, the bank doesn’t ask you to start paying down the principal until then either. During construction, you will only be expected to pay lower, interest-only payments on the loan, which will give you more time to save.
- They have flexible terms: Though you will need to provide the bank with specific plans for your project, construction loans offer more flexibility in regards to loan terms and guidelines than traditional loans do.
- The added scrutiny provides structure: Though added scrutiny may not seem like a good thing at first, during the building process, it can actually help ensure that your project stays on budget and schedule.
What are some disadvantages of a construction loan?
- They are sometimes harder to qualify for: Since construction loans are flexible, they often come with higher qualifying standards in terms of credit and down payment. Typically, you will need a score of at least 680 and a down payment of at least 20%.
- They have higher interest rates: Construction loans usually have variable interest rates that correspond to a certain percentage over the prime rate or the rate that the bank is offering. Example: if the prime rate is 4.5% and the loan rate is prime plus 2%, you would pay 6.5%.
- Shorter-term loans can be risky: Especially if you are going for the construction-only loan. At the end of the construction phase, you will need to be able to pay off the loan in full. Even If your original financing falls through, you will still be obligated to pay off this loan.
For more information or questions about how Construction loans or Renovation loans could help you accomplish your future goals, please contact me, Ryan Cox, Senior Renovation Specialist with First Integrity Mortgage Services, NMLS# 1547172 at (618) 581-3015 or email rcox@firstintegrity.com I look forward to helping you achieve your dreams!