Fixed Rate Construction Loans

The time has come to build your home and you have acquired the land. You are now ready to look at construction and have worked out the details with your contractor and have a good understanding of the costing and timelines for the completing of the project. If you are not flush with cash and able to fund this yourself, it is time to visit the financiers to see what your options are. Before doing that, it may be a good idea to have a look at what current rates are and the difference between fixed rate construction loans and variable rate construction loans.

Servicing the interest only during the construction period
One of the basic principles about borrowing money for construction loans is that it is common that such construction loans are structured to require interest-only payments. This basically means that for the duration of the construction you will be servicing the interest for the amount borrowed. The money will be disbursed following a schedule of payments that has been drawn up with the contractor. This means that the interest that you will pay is only for the amount that has actually been drawn and only when the full amount is drawn will you be paying the full rate of interest on the loan. The full loan then kicks in when the property is handed to you and the certificate of occupancy has been issued. Therefore, in such a situation, having a fixed rate construction loan may be especially meaningful as it can provide you with some assurance that you will not be saddled with a sudden rise in the interest rates, which can be burdensome for large loans.

Preparing for the risk of delays in construction
This is also important in instances when there are delays by the contractor for any number of reasons. If you had to service the interest for the entire amount from the commencement of the loan, this could work out to be a rather expensive affair. By allowing for interest-only payments in accordance with the amount disbursed, it is more equitable to the borrower. The full loan then kicks in when the property is handed to you and the certificate of occupancy has been issued.

Understanding how much you can borrow for a construction loan
Another important consideration, which should ideally be explored before sitting down to specify the details of your dream home, is how much money you will be able to get for a construction loan. Usually if you have already acquired the land, this can be charged to the financier as part of the loan security. Wit the competitive lending market, there are many financiers that are willing to lend up to 95% of the value of the property on a fixed rate construction loan. In such situations, you can usually opt that once the construction has been completed, the loan will be converted from a construction loan into a mortgage loan on the property. This may result in you initially having to pay a higher rate of interest for the period of construction, but you should be able to get a better deal upon conversion of that loan into a mortgage loan.

How fixed rate construction loans can serve you well
Ideally, you should work with the financier to determine the rates to pay. This can be done based on the amount borrowed and current economic conditions. The value of the security for your loan and the duration of the period of construction will also determine what the rates will be on a fixed rate construction loan. You can then lock in these rates and protect yourself from variations to this.

As mentioned earlier, the drawing down of the loan will be based on an agreement schedule of payments based on the completion of different stages. Usually the lender will check on this to ensure that there is no manipulation, either by the borrower or the contractor, and only once the completion of the relevant works has been confirmed, the lender will release the progress payment.

It is also useful to remember that during the period of construction, there are certainly risks that you will have to bear due to unforeseen or unexpected costs. In order to ensure that you are not biting off more than you can chew therefore, it is suggested that you negotiate with the financier for the repayment amounts to be as little as possible with the goal of converting the remainder into the full mortgage term when the project is completed.