Because there are so many financing options available to today’s homebuyers and real estate investors, it can be hard to make the right choice. When upgrading your property or building a new one, one option worth considering is a construction loan for investment property.
Renovation or construction loans for investment properties can be used for several projects but almost always allow the user to customize their space or property. Anyone interested in new construction or an extensive renovation should look into this as a viable financing option. Keep reading to learn if these loans are suitable for you, and learn how you can qualify.
What Are Construction Loans?
Construction loans are short-term financing options for new real estate or renovation projects. They are used to pay for the costs of building a new house or upgrading an existing property. Construction loans are only applicable for the time it takes to complete the project, and users only borrow what they need. These loans are distributed directly to the contractor (instead of the borrower) in segments called “draws.” Draws are marked as certain elements of the project are completed, such as the foundation being poured or the frame being built.
The main appeal of construction loans is that they enable home buyers or investors to build a new property; though, the freedom to customize a property does come at a cost. For example, construction loans are known to have higher than average interest rates. The structure is typically set up to protect lenders who trust that a project will be completed correctly and that it will be worth a certain amount when done. However, homeowners should not rule this option out because there are several perks to this form of financing.
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Different Types of Construction Loans
There are several different types of construction loans that home-builders and renovators can choose from. Let’s take a look at 4 of the most common ones:
Construction-to-permanent loans: If you’re looking for a way to finance a home construction project and a mortgage at the same time, this is the perfect two-for-one loan option. This type of loan will provide you with the funds to build a house and finance your mortgage as well. You can obtain this type of loan from banks and other traditional institutions.
Construction-only loans: These funds would be used strictly for the construction of a property.
Renovation loans: Take out a renovation loan if you plan to make upgrades to an existing home.
Owner-builder construction loans: If you’re a licensed builder, you have the option of obtaining an owner-builder construction loan. This unique type of loan will provide funders for a builder who will also own the house that they’re constructing.
Construction Loan FAQs
Construction loans may seem self-explanatory, but inexperienced investors using this type of loan may have questions about what they are and how they can use them. Take a look at some of the most frequently asked questions about construction loans before you decide if obtaining one would be suitable for your next investment project.
What Can A Construction Loan Be Used For?
A construction loan can be used for a number of projects, depending on your lenders’ requirements and terms of agreement. Here are a few of the ways to utilize an investment property construction loan:
Purchasing raw land
Building an addition to a property
Framing and finishing a house
Building sheds or other structures
Adding a garage
What’s The Difference Between A Construction Loan And A Home Loan?
A construction loan and a home loan are different in terms of what they can be used for, and as such, the approval requirements will be slightly different for each. A construction loan is used to build new structures or renovate existing ones, while a home loan is just a traditional mortgage. Both types of financing will require a credit check and other financial information, but a construction loan will also require the project plans to be approved before the loan is issued.
Additionally, construction loans can only be used for the duration of the project. On the other hand, home loans are issued for a set period until they are paid off. Borrowers who rely on construction loans will typically refinance their property after the project is completed and enter a more traditional loan. To do so, homeowners will go through a property inspection and appraisal.
What’s The Difference Between A Construction Loan And A Renovation Loan?
The difference between construction loans and renovation loans lies in the type of project. Construction loans are used for new properties with definitive project plans. Those who use construction loans will also typically transition into a regular mortgage at the end of the construction project. In contrast, renovation loans for investors are used to purchase fixer-uppers or to renovate existing properties. These loans can be used for cosmetic and structural fixes, like insulating a house or upgrading a kitchen.
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Can You Get a Construction Loan For An Investment Property?
Yes. You can get a construction loan for an investment property if your project plans and finances meet designated lender requirements. Unlike some home loans, there is no process stating that a construction loan must be applied to a primary residence. Construction loans can be a great option for financing an investment property for many reasons. Most notably, real estate investors likely have experience working with contractors and supervising renovation projects already. Therefore, they may be well suited to oversee the construction of a new property.
There are also renovation loans for an investment property obtained by following a similar approval process. Investors interested in a renovation construction loan will find that the loan is distributed based on the after repair value of the property in question. This is where your investor tool kit will come in handy. Rely on a good rental property calculator and contractor when determining whether or not a renovation loan is the right move for a specific project.
How Can I Qualify For A Construction Loan?
To qualify for a construction loan, borrowers must meet several financial requirements in addition to having their project plans approved. To begin, lenders will typically review your debt-to-income ratio and credit. While the specific requirements vary based on your lender, many ask for a credit score of 650 or more. Borrowers must also have a down payment when setting up a construction loan, which should usually be between 20 and 30 percent. Make sure you shop around when searching for a lender; there are numerous options available for obtaining a construction loan, and each will come with different requirements.
To get the final approval for a construction or renovation loan, you must also submit the project’s construction plans. Lenders will want to see detailed plans for the property and a team of qualified builders attached to the project. It is important to know that while you do need finished plans for the final loan approval, you can get preapproved for a construction loan before buying a property.
Best Type Of Loan For Investment Properties
Three construction loan types are best for investment properties: fix and flip loans, purchase and rehab loans, and construction/purchase and build loans. Typically, investment construction loans are reimbursement loans. In this case, the lender will pay for each stage of construction as it is completed and signed off by inspectors. Let’s take a look at the best types of loans for constructing investment properties:
Fix & Flip Loans: These loans are ideal for the opportunist who has experience in buying, fixing, and reselling properties within a short period. You will find that most conventional lenders and banks will have no problem financing these projects as long as you comply with common sense hard money underwriting guidelines. What will matter the most for this loan is your experience in effectively flipping properties for-profit and the viability of the project in question.
Purchase & Rehab Loans: These loans are best for purchasing old or outdated properties and either demolishing them to construct a new one or completely remodeling it to fit today’s standards. Again, the underwriting will be the most important thing to get this project started.
Construction Loans/Purchase & Build Loans: These types of loans are available in the purchase of a lot or for construction on an existing lot you own. Construction loans and purchase and build loans are specifically for non-owner occupied properties with the intent of retail or future rental income.
The idea of customizing a property from start to finish may seem impossible, both for homeowners and investors. However, this is not the case. With financing options like a construction loan for investment properties, building a new property does not have to be a distant dream. While there are approval requirements for this form of financing, it can open new doors to anyone interested in purchasing raw land or fixer-uppers. Consider a construction or renovation loan when you plan a project; it might lead to amazing results.
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The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only.