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Understanding the two types of construction loans

Understanding the two types of construction loans

The most common obstacle one faces when building a dream house is the unfamiliarity with financing options and choosing the right construction loan. Popular financial institutions generally offer two types of construction loans—construction-to-permanent and stand-alone construction loans. The former type of loan allows you to borrow sufficient mortgage to finance the construction of your house and once the project is completed, the bank transforms the pending loan balance into a loan mortgage. In the latter type, the amount is first advanced as a loan to pay for the construction after which a mortgage is given to repay the pending construction loan. In brief, the construction-to-permanent model is two loans wrapped into one, while the stand-alone construction is two separate loans in itself. Read on to know more about these types of construction loans.

Construction-to-permanent loan: In this type of construction loan, when the construction is ongoing, a borrower has to only pay the interest on the pending balance; the moving interest rate is based on the market fluctuations of the prime interest rate. This fluctuation is highly dependent on the decisions of the Federal Reserve which can alter the interest on short-term loans, thereby impacting a borrower’s interest rate.

Upon completion, the loan is converted into a permanent mortgage which is similar to the traditional mortgage system. The interest rates and the down-payment for the mortgage both depend on the bank’s restrictions as well as the borrower’s financial standing.

Stand-alone construction loans: This is a great option for those who have funds to finance a sizeable down-payment. In such a scenario, most homeowners who are looking to sell and move to a newer home can easily finance the down-payment by selling the current house when the construction on the new house is complete. A borrower has to essentially pay separate fees for the construction and mortgage loans; the mortgage rates will be decided only after the construction phase is completed. Moreover, a change in the borrower’s financial situation can impact the securing of the mortgage loan.

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