Construction Loan

A construction loan is any loan made to finance the construction of real property.  Typical construction loans would include condominium projects, new homes, or commercial property.  If the project isn’t sold post-completion, the outstanding balance is typically due or permanent financing put in place.  A new appraisal is usually done on project completion to determine the current value of the completed project.

Construction loans typically fall into two categories:

• Fixed interest rate (lock in today’s interest rate over the life of the construction loan), or
• Variable interest rate usually tied to the Prime Rate. 

Fixed interest rate options are best if prevailing interest rates are generally expected to go higher, whereas variable rates are better provided interest rates are expected to move lower.  This can be a tough decision to make as the direction of interest rates is hard to predict at best.  Construction loans are usually issued with a 12 to 18 month timeframe, but this can vary widely.

Construction loans are similar in style to a home equity line of credit in that funds are typically withdrawn from the loan as they’re needed to pay contractors, workers, and related expenses.  Some construction lenders allow such draws to be requested online, while others require paperwork and scheduled inspections.

Underwriting standards are quite high for construction loans, as there are a variety of factors that could change the probability of loan repayment.  For example, bad architecture, poor construction, non-payment of workers (which results in a “mechanics lien”) or inappropriate soil standards for the type of project.