If you’re looking to build your dream home, you may have everything down to the doorknobs planned out, so you might think all this careful planning qualifies you for a traditional mortgage. Well, guess again. To build your dream home you’re going to need a construction loan. Learn how these loans differ from ordinary mortgages and what you can do to avoid the pitfalls that come with construction financing.
Banks consider construction financing especially risky. For one thing, if you stop making payments the bank has nothing to fall back on except a patch of concrete and your broken dreams.
Due to this perceived risk on the part of lenders, construction financing has some quirks to say the least, especially when compared with a traditional mortgage.
• Given in draws- Unlike a traditional mortgage construction financing isn’t given all at once. Instead you’ll get a few thousand dollars every so often to pay for each phase of your construction project in what’s known as the draw process. In order to get more money throughout the course of your project your lender will usually need to verify that you’ve exhausted your previous draw.
• Short term- You won’t be paying back these sorts of loans for 30 years like a regular mortgage. This type of financing is usually paid back in full within 12 months.
So, why not just get a line of credit or simply borrow against your previous home to finance construction, well construction financing does offer some unique benefits:
• The added scrutiny from the draw process can keep you from overspending.
• Because of the draw process, you’ll also only be making interest payments on money you’ve actually spent instead of the full loan amount
• In addition, this type of financing is interest only, which means a lower monthly payment overall
But interest only means your lender will also expect you to pay back the loan amount in full after you’ve finished construction, or once the loan term runs out. So If work stalls or if your previous home’s sale doesn’t’t cover the cost of your loan, you’ll be in trouble.
Two simple ways to avoid risk when it comes to Arizona construction loans
• Have refinancing in place ahead of time- Since you’re building your dream home, for the purposes of living in it, you’ll need to have what’s called, a construction to permanent loan. This type of loan puts refinancing in place ahead of time, so you can pay your lender back once construction is finished. That is unless you want to sell the home of your dreams to someone else, or you plan win the lottery.
• Have a reputable contractor on board- With construction financing, having a good contractor is almost more important than having a good plan. If a good for nothing contractor holds up work for any reason, your next draw might not get approved. You won’t have the funds to keep paying your contractor, work stalls and your lender might demand repayment regardless if your house is finished or not.
Following these two tips, will protect you from risk and help you maximize the benefits of construction financing.
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About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.