Interest Only Construction Loan

An interest only construction loan provides individuals with the funds needed to build a home according to their personal specifications. Homebuyers who aren't satisfied with listings in the current market or who have very specific desires for a house may choose to finance the custom-building of their own home. Interest only loans are a special type of financing when the borrower only pays the interest accrued on the amount borrowed for a fixed period of time. The principal remains unchanged during the time frame, usually during the building period of the home, and is usually paid in full upon completion or rolled over into another, longer-term loan, or in this case, a mortgage.

Often called story loans, construction loans usually are not approved until the lender understands the "story" of why the financing is needed. Unlike a mortgage, an interest only construction loan is not standardized. Interest rates are usually variable and the amount lent to a homeowner depends on the cost of the project and how much the property will be worth at the conclusion of the building period. The amount of equity already built in the property is also taken under consideration and can be used as security against the borrowed funds. In cooperation with lenders, homeowners open a line a credit to draw against. Installments begin immediately, but only include the amount of interest on funds borrowed to date. Money is lent in stages according to the phases of the project: grading the site, pouring foundation, framing the house, plumbing and wiring, installation of interior surfaces (including cabinets, fixtures and trims), and painting. However, the time period associated with an interest only construction loan is fixed, so borrowers must allow enough time for the whole project to be completed including extra time for any unforeseen delays.

Since construction loans aren't meant for long-term financing, interest rates are usually variable depending on the federal annual percentage rate (APR). Some lenders will offer to lock in rates throughout the duration of the contract, especially if the homeowner chooses to rollover the interest only construction loan into a full mortgage with the same company or decides to use a construction to permanent loan (CTP). With this type of financing, the lender automatically converts the loan to a complete mortgage. On single-close CTP loans, the borrower saves time by only filling out one set of application materials and money through only one closing. Sometimes rates for construction to permanent loans are a little higher than the variable rates at the time, but if fixed rates are lower, it might be the best time to lock the rate in for the duration of the mortgage. The traditional, double close CTP loan programs are actually two loans - a construction loan and a permanent mortgage loan - and include two sets of application paperwork and two closing costs.

Approvals for an interest only construction loan isn't as easy as securing a complete home mortgage. Application materials usually require standard information such as current address, phone number, social security numbers of the borrower and co-borrowers and other sources of income such as rental properties, disability payments, or child support. Information on a borrower's employer, paycheck stubs, as well as complete information on personal assets and liabilities must also be included. As with any other type of financing, good credit scores are very important. Most lenders won't approve loans until land has been purchased. Generally, a credit score of 660 or above is necessary to purchase land. The more equity borrowers have built up in land purchase increases their chances of approval. The application process also includes an interview with a loan officer who will explain financing options as well as help with filing needed paperwork. Any debt current debt problems should be discussed during this interview. The Bible advises us to live above reproach. "Finally, brethren, whatsoever things are true, whatsoever things are honest, whatsoever things are just, whatsoever things are pure, whatsoever things are lovely, whatsoever things are of good report; if there be any virtue, and if there be any praise, think on these things." (Philippians 4:8)

Many people have taken out a construction loan even when they have the funds available to pay for the project. Getting an interest only construction loan provides a kind of insurance that homeowners couldn't get otherwise. Since banks and lenders now have an invested stake in the property, they are very willing to provide financing expertise to the builder. A lender can evaluate estimates from contractors and suppliers to make sure that the homeowner is not getting overcharged. By dealing with these costs regularly, these "experts" know the going rates and can advise the range of prices to expect as well as warn a borrower if an estimate doesn't look right. And since they control how the money is released at the various stages, lenders will make sure that contractors are completing the job agreed upon. However, interest only construction loans do have a few drawbacks. Fees and interest rates raise the cost of a project. The paperwork process is tedious. And since forms are not standardized, the process could take longer than expected. If a project overextends the term agreed upon, the lender will charge extra fees and penalties.

And interest only construction loan can be very beneficial for an individual or family who wants to build a home but may not have all the money in hand to begin making full payments from the beginning. Since these unique loans often are made for six, twelve or eighteen months, the borrower has some time before paying full mortgage installments. Plus, by acting as builder and overseeing the construction of their home, the final product can be the home of their dreams.

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