The Differences Between Construction Loans and Long Term Mortgages
Let’s talk about a couple of differences between a long term mortgage, and a construction loan. I think it is helpful to understand these differences as you begin the construction loan approval process.
The main difference of the loans centers on the collateral. As we have discussed, the collateral has not been built yet, so there are different risks that a construction loan has that a long term loan doesn’t. For instance, when you buy a house, all the money gets transferred to purchase the house, and clear title is transferred, and the 1st lien position is secured. On a construction loan, a lot more can go wrong. There are opportunities for mechanics liens, disbursement issues, and many more opportunities for fraud. Now there are policies and procedures in place to safeguard these issues, but these types of problems don’t manifest themselves in a long term loan.
Another difference dealing with the collateral is the builder himself. He is a person that doesn’t guarantee the loan, but is really responsible for building the collateral. Having problems with your builder can delay the project, jeopardize your budget, and put the project at risk. It is a good idea to pick your builder wisely.
Something else to note is the interest rate. The interest rate on a construction loan is important, but since it is only a short term loan, it’s not nearly as important as your long term loan. For example, on a $300,000 loan, a 1.00% difference for a six month construction loan from 4.5% to 5.5% would be approximately $975. For the same 300,000 loan, the difference of 0.125% on a 30 year loan from 5.0% to 5.125% would be $8,280. Many get hung up on the interest rate, when the other features of the loan, like fees, down payment, and flexibility will mean more when it’s all said and done.