Construction Loan Interest Rates | Compare
Construction Loan Interest is Charged Monthly
Construction Loan Funding
Construction loans are almost always funded by financial institutions such as banks and credit unions. Banks and credit unions define construction loans to be short term since construction is typically completed in 12 months or less and the loan is payable when construction is completed.
Construction loans are also deemed to be riskier than permanent loans since many things can go wrong during construction and the lender might be stuck with a half-finished house. Both the short-term nature of the loans and the increased risk associated with construction loans factor into the interest rate.
Amortizing vs. Non-Amortizing Loans
When you get a 30-year or 15-year mortgage on your home, it is what is called an amortizing loan regardless if it is fixed rate or adjustable rate. That simply means that part of the principal (loan balance) is paid each month along with the interest on the loan. Each month, the balance of the loan decreases and at the end of the loan term, the loan will be completely paid off.
A non-amortizing construction loan means that no principal is repaid during the course of the loan, and the full balance is still in place at the end of the loan term. Such loans are also know as interest-only loans and the interest is paid monthly. Construction loans are typically interest-only loans.
Construction Loan Fund
Unlike a permanent mortgage, the funds for construction loans are not disbursed at closing. Typically, the bank will disburse 10 percent of the loan balance at closing to cover plans, permits and other initial construction costs. The remainder of the loan balance is placed in a construction loan fund and disbursed to the borrower as each phase of the construction is completed.
Loan Balance During Construction
The money for a residential construction loan is only disbursed as each phase of construction is completed. As the borrower, you will only have to pay interest on the amount of funds disbursed, and you will only be required to pay the interest and none of principal. For example, if your loan amount is $200,000 and the financial institution has only disbursed 10 percent of the funds ($20,000), you will only pay interest on the $20,000. Interest is billed at the end of each month and is based on the average loan amount outstanding during the month.
Residential construction loan interest rates "float" during the construction period. Float means that the rate will change when a specified index such as the prime rate changes. The prime rate is published in the Wall Street Journal and refers to the rate banks charge to their best customers. Construction interest rates are generally set at prime rate plus two percent. So if the prime rate is two percent, you would be charged a total of four percent.
View Article: Construction Loan Rate Vs. Permanent Loan Rate
If the prime rate is increased to 2.5 percent, then the rate charged on your loan would be increased to 4.5 percent for the remaining term of the construction loan or until the prime rate is changed again. Be aware that when interest rates start rising, that they might continue to raised three of four times during the term of your loan. This can increase the cost of your loan considerably. This is why it is important to have an agreed upon construction term with your builder. If the builder does not complete the construction on time, the builder should be required to pay additional interest that you incur.