A construction loan is a short-term type of loan that’s used to pay for building a house or other real estate project. The best construction loans have competitive fixed interest rates, low down payment requirements and other additional benefits such as fast loan approval or the ability to lock in an interest rate for a set time. Let’s take a closer look at how construction loans differ from other popular loans and four of the best construction loans of 2019.
The 4 Best Construction Loans
|Lender||Premiums||Down Payment||Key Benefit|
|First National Bank||Low fixed interest rates; interest-only payments during construction period||20%||Only close once; construction loan converts to a permanent loan after construction is completed, or after 12 months reducing overall loan fees|
|U.S. Bank||N/A||20%||Face-to-face support|
|Wells Fargo||Lock-in interest 24 months||11%||Online application available and a strong network of loan officers|
|Normandy||10.95% APR||25%||Quick loan approval, within 21 days|
What is a Construction Loan?
Building a home is expensive and many people don’t want to pay the full amount upfront. That is where construction loans come in. A construction loan is designed to fund the construction process in a series of installments. For example, if your home build is expected to cost $300,000, the loan might be paid out in four payments of $75,000 as milestones are completed. In most cases, the loan proceeds are paid directly to the builder to fund the construction process.
Rates and Terms
Construction loans are short-term, often coming with a term of one year, which is meant to align with the time it takes to build the house. During the construction, borrowers typically only make payments toward the interest on the amount they have withdrawn. So, for example, if you are approved for $300,000 but have only withdrawn $75,000, you would be paying interest payments on the $75,000 balance each month.
Construction loans are riskier for lenders because there is no asset to secure the loan yet and no guarantee the home will be built as planned. As a result, the minimum down payment is often at least 20% to 25% of the loan amount, the interest rates are higher than you find on a traditional mortgage and the eligibility requirements are strict.
Common Eligibility Requirements
Common requirements include that the builder involved must be qualified and licensed to build; you must have detailed specifications of the construction; an appraiser must estimate the value of the constructed house and you should typically have a credit score of 680 or higher.
Types of Construction Loans
At the end of the term, the next step depends on the type of loan for which you have signed up. Construction-only loans become due in full at the end of the term. This may be a good choice if you plan to sell your old home for an amount that covers the loan costs. However, you can also opt for a construction-to-permanent loan, which automatically converts the construction loan balance into a regular mortgage.
Construction Loan vs Traditional Mortgage
Unlike a traditional mortgage, construction loans are not long-term loans that allow you to pay off your home’s cost over time. They are short-term loans with higher down payment requirements that are designed to fund the build and get paid off. In fact, many people will use a traditional 30-year mortgage model to pay off a construction loan.
With a construction loan, payments are paid out after each phase of construction is completed, instead of a lump-sum payment associated with traditional mortgages. Additionally, lenders of construction loans will also require more information than a traditional loan, such as detailed construction plans and budgets.
Construction Loan vs HELOC
A construction loan enables you to build a home through payments that are disbursed over a term. Alternatively, a home equity line of credit — also known as a HELOC — is a revolving credit line that is secured against your existing home’s equity. HELOCs have lower interest rates than construction loans as they are secured by an existing home. However, like a construction loan, you only pay interest on the money you’ve withdrawn during the draw period. When the draw period on a HELOC ends, which is often after 10 years, the repayment period begins in which you repay the principal balance plus interest over an extended period of 15 to 25 years.
Construction Loan vs Home Equity Loan
A home equity loan is sometimes also known as a “second mortgage.” It allows customers to use their home equity to borrow a lump sum of money. The loan amount is based on the difference between a homeowner’s mortgage debt owed and the home’s current market value. The equity in the home is the collateral for a lender. In contrast, with a construction loan, the lender doesn’t have collateral, so the lender usually charges a higher interest rate and have more stringent requirements to qualify for lending. Also, you make repayment of principal and interest over a longer period with a home equity loan, instead of full payment after one year with a construction loan.
The 4 Best Construction Loan Lenders
First National Bank – Best for reducing loan costs
The First National Bank offers fixed interest rates and interest-only payments during the construction period. Typically, a down payment of 20% is required but less may be allowed of you have private mortgage insurance. The best thing about this lender’s construction loan is that it converts to a permanent loan after the home is complete, or after 12 months, so you only have to pay one set of closing costs.
U.S. Bank – Best customer support
U.S. Bank is well-versed in the construction loan sector and offers several types of construction loans. The interest rates are not specified on its website but it assigns a personalized loan officer who meets with you, in-person, to discuss the rates and loan terms. The bank typically requires a deposit of 20% and is available in 41 states in the U.S.
Wells Fargo – Best for reducing interest rate payments
Wells Fargo allows customers to apply for construction loans online and has a large network of loan officers available over the phone. The bank also lets customers participate in their Builder Best Extended Rate Lock program, which locks in an interest rate for up to 24 months, so customers don’t have to rush into choosing a builder or finalizing designs before funding construction.
Normandy – Fastest loan approvals
Normandy typically charges an interest rate of up to 10.95% APR and requires a minimum deposit of 25% for construction loans. It’s ideal for time-strapped customers, as loan approvals are typically completed within 21 days. It also provides the option for a 14-day fast-track closing for a fee of $1,250.
The Final Word
The First National Bank stands out among construction loan lenders. It offers some of the best construction loan rates and terms, helps customers reduce loan fees with construction-to-permanent loans and offers flexibility with down payments. However, it’s always important to shop around. Construction loans are not as cookie-cutter as many other loan products, so it’s important to speak with the lenders. We recommend you get at least three custom quotes to compare, and look for the best value in terms of the loan amount, cost during the term, additional features and overall cost.