The Dos and Don'ts of Construction Loans
Construction loans can help cover the costs of home construction. But it’s vital to know all the details before signing the dotted line.
Building custom homes is one of the most rewarding jobs a contractor can have. Taking a floor plan with new concepts and unique designs and watching it come together into a beautiful new home is satisfying to all who have a hand in the project.
We know that the terms of a loan can be difficult to understand. So we’re breaking down the dos and don’ts of these complex agreements below.
What is a Construction Loan?
Construction loans are short-term loans used to finance the building of a home. Due to the lack of collateral, these loans typically have a much higher interest rate and require at least a 20%-30% down payment [NerdWallet].
The upside of these loans lies in the draw process and interest accrual. Recently, a Denver builder was granted a $26 million construction loan to build a downtown apartment complex. If the builder were to draw all $26 million upfront, the cost of the interest alone would be staggering [Multifamily Press].
Instead, they draw only what they need, when they need it. They draw $2.5 million to get started and only pay interest on that amount until more is drawn. They’ll continue to draw more as needed while the project endures. This draw process results in significant savings in interest. Once they've completed construction on the building, they’ll likely refinance to a more secure loan with a significantly lower interest rate.
Construction Loan Dos
- Do plan carefully. A build with a construction loan requires several inspections along the way. So do the work on the front end to make sure the project runs smoothly.
- Do communicate often with the lender. Keep them informed of any project delays, changes in costs, etc.
- Do partner with an experienced title company that’s familiar with construction loans and draw processes.
- Do monitor construction payments and funds carefully. Issues are much easier to resolve when caught early on.
- Do stick to the plans and timeline you provided the lender, as the appraisal will be based on that information.
Construction Loan Don’ts
- Don’t begin any construction, land clearing, or excavating until after the loan closing. This could cause significant delays to the closing process.
- Don’t allow any debts to fall past-due during the construction period.
- Don’t make any changes to the home plans or specifications without discussing it with the lender.
- Don’t take out any additional loans on the project without communicating with the lender.
- Don’t go without title insurance. Most lenders require this for construction projects to protect all parties from mechanic’s liens. It covers common title problems, such as errors in public records, illegal deeds, forgery and fraud, and unknown liens [Levelset].
CoFi Software Eases Construction Payment Pain
Construction loans can be a great tool for building dream homes, apartment builds, and custom offices. Clear communication with the lender is paramount to the success of these projects.
Enter CoFi, the technology that is taking the construction industry by force. CoFi has a streamlined approach to connecting contractors with lenders for easy communication and simplified construction payments.
The result is faster payments, less paperwork, and more doing what you do best—building. Learn more about how CoFi can help your business thrive here.