Taking out a loan for a construction project is bit different than taking out a loan for a mortgage or a business. If you are considering taking out a construction loan, you should understand the different types of loans that are available as well as the various legal issues that apply.
Construction loans are "story loans," which means that the potential lender will want to hear the story about your plan for the construction project before they lend you the money. Here, a lender will be looking to ensure that you will be able to pay the loan back, either through revenue earned from the construction project or from other means.
A construction loan will often contain flexible "contingency" funds that buffer the loan amount in the event construction ends up costing more than expected. Here, if you end up not needing the extra funds, they will simply be removed from the loan amount.
Locked or Floating Interest Rate
In some instances you will have the opportunity to negotiate either a locked interest rate or a floating interest rate. A locked interest rate will not change over the course of the loan while a floating interest rate will fluctuate with the market. Here, the better choice will depend on the nature of the market and the interest rates offered.
Interest Reserve Amount
During the course of the construction, you will only be expected to make interest payments on the loan, and these payments can be made from an "interest reserve." An interest reserve is an amount that can be added on to the initial loan to make payments on interest while the construction project is being done. Thus, it saves you from needing to have any extra capital for interest payments until the construction is complete.
Construction to Permanent Financing
In some instances, banks will allow construction loans to be altered into a permanent financing mortgage loan once construction is complete. For example, if the construction project is to build a new home for you to live in, and you anticipate it will take a long time to pay off the loan, construction to permanent financing would be a good option.
Seeking Legal Help
Before taking out a construction loan, it is always helpful to shop around at different banks to see what deals are offered. Different banks may offer different packages with competing interest rates and payment plans.
To understand your options when considering construction loans, you should consult with a broker or contact a business attorney to ensure that you obtain the deal available for your construction project.