Construction Loans
In the broadest sense of the term, a construction loan is any loan where the proceeds are used to finance construction of some kind. In the United States Financial Services industry however, the term is used to describe a genre of loans designed for
construction and containing features such as interest reserves, where repayment ability may be based on something that can only occour when the project is built. Thus the defining features of these loans are special monitoring and guidelines above normal loan guidelines to ensure that the project is completed so that repayment can begin to take place.
The term “home construction loan” is current in the United States, but other terminology may apply in other English-speaking countries. In the United Kingdom, such a loan would be called a “self-build mortgage”. These can also be referred to as Value Added Loans.
Almost all lenders are concerned that their money lent is repaid, so underwriting of construction loans usually focuses on how that might occur.
In the most basic situation, that of an individual building a home for themselves, a business building a property for business use, or an investor building a property to rent out, the fundamental guideline is for the lender to imagine once the loan has been fully extended and converted into a normal mortgage and the building is occupied, whether the individual, business, or investor can afford to pay back the loan on a monthly basis. In the case of the individual, where the lender attempts to predict whether the individual can pay each month the loan payment that would occur once the person moves into the house, the lender would be primarily looking at the amount of income the individual receives.
In the case of the business, a similar analysis would occur. In the case of an investor building rental property, a special appraisal would be ordered which would attempt to predict what the rents will be and whether they will be enough to pay back the loan, plus all expenses and still give the renter a certain minimum amount of income.
