How to use Construction Loans for Home Improvement

Construction loans are one of the smartest ways to improve a home. These short-term loans are designed to get you the money that you need quickly, and to use those funds to increase the value of your home. These loans are offered by many different banks, and at times can be the first step in a mortgage refinance. Here is a look at the details of a construction loan, and under which circumstances it can be the smart play:

What is a Construction Loan?
Construction loans are designed to get you the money you need to repair or remodel a home. These funds are usually short-term, and banks who lend them will expect you to pay off the loan with a new mortgage based on the new equity you gain with your remodel. Because of this, these loans may be slightly higher interest than others, but you can often get interest-only terms to keep your price low while remodeling.

The Structure of a Construction Loan
Construction loans often come with a certain timeline where you can purchase things, before the loan goes into a payment-only mode. During the purchase time, which can be six months to two years but is often negotiable, you are given a credit card and/or loan checkbook to spend up to your designated limit. You are usually only charged interest during the purchase time, and principal is rolled into the cost once you switch to payoff mode. At that point, the checks and card are no longer valid for purchases.

Construction Loan to Mortgage
The interest rate of a construction loan often runs close to double the rate that a mortgage can offer. This is because lenders don’t expect these to last the life of the loan, but offer them as incentives to roll into a mortgage later for a higher amount of equity. Many lenders who give a construction loan will offer the chance to move into a mortgage after it’s over, and may waive the filing and background work on the mortgage refinance, because it was already done for the construction loan. This can save you hundreds to thousands in filing fees, and makes it worth asking your construction loan lender about a combo loan while you are shopping for rates.

Are You a Good Candidate?
When you look to remodel your home, you want to have your credit in the best shape possible as the first step. Pay down what outstanding debt you can and cancel extraneous credit cards so you don’t have too much open credit. At a minimum, be sure you have no late or missing payments on the debt that you do have. The better your credit, the lower the rate you will have on both your construction loan and your future mortgage. If you have a high interest rate credit card, or several, consider rolling them into a single lower rate loan payment and pay more than the minimum on this. This will reflect better on your credit overall, and be less cumbersome to pay than several card balances.

How Much Loan Do You Need?
Finally, determine how much loan you need. Banks will use a formula to figure out how much they feel comfortable loaning you, but you should strive to need less to improve your house if possible. However, if you are looking at the upper limit of this number, consider using some of the funds to implement cost saving items into your home like very efficient lighting, heating and insulation. This will mean fewer additional bills to pay in conjunction with your new future mortgage. Also, if you do have other debt, ask the bank about rolling some of it into your mortgage equity at the lower rate.

A construction loan is a smart starter loan for home improvement, and can help you to achieve your dream loan for small cost while it’s happening. When used in combination with a new mortgage, it’s an excellent tool to have that dream home you have always wanted.