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What Are Construction Loans And How Do They Work?

Written by Jimmy Rustling

Getting into real estate construction for personal or commercial reasons is not always the easiest route to go because of the financial costs. To help cover the expenses of the construction process, it is often necessary to apply for a loan. Applying for construction business loans is a strategic step to ensure smooth cash flow during the construction process, enabling timely completion of projects.

When seeking to get these types of loans, it is crucial to understand what they are, the rates of the loans, and the financial implications that the rates may have on you.

How to get a construction loan:

When seeking a construction loan from most lending institutions, it can be challenging to qualify especially if you do not have collateral apart from the house yet to be constructed. However, if you have a stable income and excellent credit, you can quickly get the loan. You also need to have at least a 20% down payment and a low-debt to income ratio.

Seasoned investors are significantly more prone to take construction loans for building homes or redoing old properties.  Hard money loans are good to consider for new constructions as short-term loans can easily finance the construction. As with other hard money loans, a part of the funds you receive are distributed at the end for lot acquisition, as the rest are held in escrow. Those in escrow are given out in bits after certain phases of the work are completed.

The construction process is distributed into phases with precise budget requirements for each step for money use and distribution planning purposes. Inspection is done with each completed phase, and when the moneylender receives confirmation, more funds are distributed in three days. This helps you and your lenders keep the project on track and within budget.

Which lender is best for your construction loan?

You can use many institutions to get your construction loan, from public institutions, banks, online lenders, and private institutions. The loan you receive is usually proportionate to the lot value and the cost of repair and construction. Private lenders offer great deals for hard money loans since no minimum credit score is required.

Experience helps you make the best construction loan decision. Some private lenders can fund up to 70% of the land value and cover 100% of the construction expenditure. All this is capped at 75% of the ARV. The interest rates are also significantly lower, ranging from 9 to 11% with an up to 18% term.

It is also essential to find a lender who gives you a quick close. Good private lenders should offer this in as little as 48 hours with a close time of ten days. This is an advantage compared to the minimum of 60 days to close.

Closing the deal on a hard money construction loan:

Getting a construction loan is a different process from getting a conventional mortgage. Conventional mortgages require a lot of paperwork, while construction loans have lighter documentation needs. On completing the loan application, the loan officer in charge and the underwriter will review the deal with you. If the value fits their specifications, an appraisal is ordered.

An underwriter makes sure that you are experienced and that the construction plans and other relevant documents are credible. Be sure also to get the term sheet so that there are no hidden fees you are not notified about. After all the formalities were done, an attorney processed the loan and closed it.


Constructing your dream home or getting into real estate is undoubtedly made easier with construction loans. The essential process is contacting a lender who understands your vision and comments on helping it come to life.

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About the author

Jimmy Rustling

Born at an early age, Jimmy Rustling has found solace and comfort knowing that his humble actions have made this multiverse a better place for every man, woman and child ever known to exist. Dr. Jimmy Rustling has won many awards for excellence in writing including fourteen Peabody awards and a handful of Pulitzer Prizes. When Jimmies are not being Rustled the kind Dr. enjoys being an amazing husband to his beautiful, soulmate; Anastasia, a Russian mail order bride of almost 2 months. Dr. Rustling also spends 12-15 hours each day teaching their adopted 8-year-old Syrian refugee daughter how to read and write.