How do Hard Money Loans Work?
Construction loans usually have variable rates that move up and down with the prime rate. Construction loan rates are typically higher than traditional mortgage loan rates. With a traditional mortgage, your home acts as collateral — if you default on your payments, the lender can seize your home. With a home construction loan, the lender doesn’t have that option, so they tend to view these loans as bigger risks.
Because construction loans are on such a short timetable and they’re dependent on the completion of the project, you need to provide the lender with a construction timeline, detailed plans and a realistic budget.
Once approved, the borrower will be put on a draft or draw schedule that follows the project’s construction stages, and will typically be expected to make only interest payments during the construction stage. Unlike personal loans that make a lump-sum payment, the lender pays out the money in stages as work on the new home progresses.
These draws tend to happen when major milestones are completed — for example, when the foundation is laid or the framing of the house begins. Borrowers are typically only obligated to repay interest on any funds drawn to date until construction is completed.
While the home is being built, the lender has an appraiser or inspector check the house during the various stages of construction. If approved by the appraiser, the lender makes additional payments to the contractor, known as draws. Expect to have between four and six inspections to monitor the progress.
Depending on the type of construction loan, the borrower might be able to convert the construction loan to a traditional mortgage once the home is built. This is known as a construction-to-permanent loan. If the loan is solely for the construction phase, the borrower might be required to get a separate mortgage designed to pay off the construction loan.
