1. Short-Term Nature: Construction loans are typically short-term loans, often with terms of one year or less. They are designed to cover the costs of the construction phase of a project.
2. Disbursement in Stages: Instead of receiving a lump sum upfront, borrowers usually receive the loan funds in installments or draws at different stages of the construction process. The lender may inspect the construction progress before disbursing funds for each stage.
3. Interest-Only Payments: During the construction period, borrowers typically make interest-only payments on the loan. These payments cover the interest that accrues on the outstanding loan balance but do not pay down the principal.
4. Transition to Permanent Financing: Once the construction is complete, the borrower typically refinances the construction loan into a long-term mortgage or other permanent financing options. This allows the borrower to pay off the construction loan and establish a more extended repayment plan.
5. Lender Requirements: Lenders offering construction loans often require a detailed construction plan, a budget, and a qualified builder or contractor to oversee the project. The borrower may also need a down payment, typically a percentage of the project's total cost.
6. Loan-to-Value Ratio: Lenders usually limit the loan-to-value (LTV) ratio for construction loans, meaning they may only finance a portion of the project's total cost. The borrower may need to contribute a significant portion of the project's funding.
7. Creditworthiness: Borrowers will need to demonstrate good creditworthiness and financial stability to qualify for a construction loan.
8. Types of Construction Loans: There are different types of construction loans, including construction-to-permanent loans, which combine both the construction and permanent financing into one loan, and stand-alone construction loans, which require a separate loan for permanent financing.