Getting funding for a construction project, residential or commercial, is quite a different process than obtaining a standard mortgage on an existing property. That’s because funding a construction project is much more complex than a relatively cut and dry purchase of property.
A construction project will have its own requirements and needs for financing—which is usually disbursed on a draw schedule—based on sometimes difficult to predict costs for materials, labor, etc. Then, once the construction is completed, the project will usually be subject to a mortgage.
Generally speaking, there are two main types of construction loans which owners, lenders, and contractors can choose to utilize: One-Time-Close loans or Two-Time-Close loans.
As the name indicates, the main difference between these two construction loans is the number of closings that will have to occur. A closing is the final step in a real estate transaction.
Thus, one-time-close loans will only involve one closing. What this means is that the financing for both the construction and the mortgage on the completed project will be wrapped into one loan.
The terms of the loan, though not necessarily the final rate, will be decided upon before any construction begins. Once the loan is settled with the lender and closed, the construction can begin. Usually, one-time-close loans allow for a period of 12 months for the construction to be completed. Most owners will either pay interest on funds as they are released in accordance with the construction draw schedule, though some may begin making mortgage payments right away.
Once construction is completed, the loan will usually convert into a 29 year mortgage (accounting for one year of construction out of a standard 30 year mortgage). Depending on the lender, the rate may remain the same as it was during the construction period, or you may be able to pay to have the interest rate reduced.
A two-time-close construction loan is actually two separate loans. It involves obtaining financing for the construction project, and separately obtaining financing for the mortgage on the finished project. Since you will be seeking out two loans, there will be two closings as well which will mean you will have to pay closing costs twice instead of just once. The first closing will occur prior to the construction and it will detail the terms and draw schedule of the construction project. Owners will only have to make interest payments that will increase as construction progresses.
Once the project is completed, the loan will be refinanced with the lender into a permanent mortgage. Doing so usually allows the owner to obtain a better interest rate on the final mortgage compared to the construction interest rate. Two-time-close loans benefit from increased flexibility compared to one-time-close loans. If there are construction cost overruns, you can account for them in the second phase of financing.
If you are interested in obtaining a construction loan, or you are facing a construction loan dispute or foreclosure, please contact the Florida Construction Law Group today.