4 Questions to Ask Construction Loan Lenders

Construction loan lenders offer a special type of loans to borrowers. When you take on a construction loan, you are borrowing money to build something, making it a more risky loan for the lender. The loan is risky because there is no current collateral to guarantee the money that they are lending. As such, construction loan lenders choose their borrowers carefully. You should follow their lead and be careful when making your choice to ensure that the lender will treat you fairly and provide fair loan terms. Here are a few key questions you should ask construction loan lenders?

Question 1: How much money do I have to put down?

When buying an existing house, 20 percent down is standard. You can usually invest even less. This isn't really an option with construction loans because of their inherent risk. As a general rule, you should expect to put down a minimum of 20 percent of the cost to built. You may need to put down even more if your credit is damaged in any way. The additional downpayment gives that bank the extra protection they need to finish the home, just in case you did not. 

Question 2: What is my interest rate?

The interest rate is the amount of money that you are charged in order to borrow. For many construction loans, the interest rate is an ARM rate, not a fixed rate. This means it is tied to a financial index and the rate . changes as that index changes. Your payments can change with it. If the index goes up, your payment will increase. If it does down, your payment will decrease. 

Question 3: What will I be paying?

Most construction loans are interest only, which means you only pay the interest on the loan, and do not any of the principle. In addition, you typically only pay interest on the money that has been used for the construction. The entire balance is not given to you all at once, it drawn from an escrow account and is used to pay for construction costs. 

Question 4: What are my costs and draws?

Four or five draws are the most common number of draws. Usually, each draw is followed by an inspection by the lender. The lender appraises the home to be sure it is properly progressing. Some banks charge a fee for these draws and the inspection.

You will have to pay costs to close any loan. This usually includes points, origination fees, processing, credit, underwriting, escrow and title insurance. You will also have to pay closing costs again at the end of your loan. Compare various company fees to get a better idea of what is fair. Then, negotiate. Most lenders are willing to reduce some of their fees to keep your business, as long as it is fair. Request a good faith estimate from all of your lenders so that you can compare everything in writing and document everything you are quoted.