Steven wrote me asking about residential construction loans, mortgages designed for building homes. There are two main types of building loans and a borrower's choice will depend on local availability, monetary resources, and personal preference.
The first method is short-term financing. During construction, incremental funds are issued to the contractor in draws to pay for labor and materials, as needed. After construction is complete, the temporary construction loan must be paid in full.
The second method is all-in-one financing which rolls together both the short-term construction and permanent financing aspects into one loan.
Short-term construction loans are temporary in nature. These loans must be followed by a permanent mortgage refinance after construction is complete. Banks generally require them to be paid back in one year.
Sometimes a builder applies for the temporary financing, other times the homeowner applies. Either way, the homeowner is responsible for arranging the eventual permanent financing.
Advantage: When the borrower refinances the short-term construction loan, the permanent interest rate is usually lower than the rate offered on all-in-one loans.
Disadvantage: If borrower fails to prepare properly or encounters a hardship while the home is being built, there can be a scramble for permanant financing at the end of the year. Talk about stressful.
Another type of building loan is the construction-to-permanent, also known as the all-in-one. Financing encompasses both stages, short-term construction and long-term permanent, in one lending process.
Beginning with a short-term construction loan, it converts to a permanent mortgage upon completion of the dwelling.
Advantages: The homeowner only incurs one set of closing costs for both aspects of the financing and can lock in their interest rate sooner.
Disadvantage: Interest rates for all-in-one construction loans are generally higher than the rate on a refinance used to pay off short-term financing.
Here is your next stop in my home buying series. When private mortgage financingoriginates between family members, property tax and mortgage interest deductions frequently come into question.
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