Choosing a loan for your construction project is one of the most important decisions you will make. It is a long-term agreement with sizeable financial implications, and it is essential that you find a reliable partner that will ensure a tidy, transparent and stress-free process. Financial terms are the main point of focus, but you must also consider the lender’s reputation and their ability to assist you through the various stages of the construction project.
“The right loan” is the one that best addresses your project’s specific needs. Therefore, before you consider different construction loans, first you must assess your project and your financial means to determine the scope of the loan you will need. After that, it’s all about finding the best deal with a trustworthy lender.
The Changing Landscape
The construction loan landscape has gone through significant changes in recent years. In the aftermath of the housing boom and its eventual collapse in the early years of the century, a combination of new, stricter regulations and a higher degree of caution from lenders has seen a significant drop in the overall volume of issued loans.
Banks, especially lenders with the highest involvement in construction loans traditionally, have taken a big step back and tightened their requirements for loan approvals, enabling the non-bank lenders to fill this gap.
While this shift from banks to non-banks has been more visible in mortgage loans, construction loans have also been affected by this trend. From the perspective of the loanee, the choice between a bank or a non-bank lender is not all that different, however. While non-bank lenders may be a bit more flexible with their terms and requirements, their offers aren’t dramatically different.
Types of Construction Loans
Construction loans are distant, slightly more complicated cousins to the traditional mortgage loans. Construction loans are issued for buildings that haven’t yet been built, which requires a different, more hands-on involvement by the lender, who approves your chosen contractor, dictates the timeline for the disbursement of funds and oversees the construction project.
A construction loan is closely connected to a permanent mortgage loan, which is necessary upon the project’s completion. A few most common types of construction loans arise from this distinction:
- Construction-to-permanent (“single close”) loan: this type of loan is an all-in-one solution that converts a short-term construction loan into a permanent mortgage loan once the construction project is complete. It is a popular option since it simplifies the process and does not require the loanee to separately apply for a mortgage loan once the construction is done, thus saving time, closing costs and the costs of reapplying. It is ideal if you have a clear plan on the construction and its costs, and if you are looking for predictable and stable interest rates.
- Standalone (“two-time-close”) construction loan: this short-term loan only covers the construction project, but requires you to acquire a separate permanent mortgage loan when you complete the project. Because there are two separate loans, the closing costs are greater, and you have to go through the application process all over again. On the other hand, it allows you to “shop around” once you complete the project and find the best rates for your permanent mortgage loans. It also provides you with the added flexibility of potentially borrowing more in case you add any upgrades to the construction project.
- Renovation construction loan: this type of loan allows you to include the costs of major renovations into your mortgage, instead of financing them upon closing. Most commonly, you will look for this type of loan if you wish to buy property in need of significant construction work. The important thing to note is that the loan will be based on the value of the property after the renovation is complete, and not in its current state.
What to Look For
First, let’s get the obvious out of the way: before you make your decision, do your best to research all the available lenders and find the best rates and terms. A bit of legwork can help you find a better deal.
As we’ve already mentioned, construction loans are a bit more complicated in comparison to mortgage loans. Ideally, you will look for a lender with experience in this field who will able to present you with the various options offered and guide you through the construction process.
The lending policies differ from lender to lender in many aspects, whether its approval requirements, inspection procedures, or draw schedules. Think hard about which of these policies best suit both you and the contractor.
Lenders can be quite helpful with realistic budget projections, which is often a slippery slope for the loanee and the contractor. Ask different lenders how they can help you in this department.
Lenders also have different policies regarding any existing mortgages on the loanee side. This is another aspect to consider and ask questions about if you already have a mortgage on your current home.
Finally, trust goes a long way. If you have a long standing relationship of trust with a bank, you may consider going with their loan, even if they don’t offer the best rates. You can even use your existing relationship to try and negotiate a better deal in exchange for your loyalty.
Ultimately, your choice of lender will depend on a variety of factors specific to your project and your financial state. There is no foolproof way to choose the best lender, but covering all areas and paying attention to all the aspects of the future agreement will set you on the right path towards a successful, stress-free completion of your construction project.