Construction lending consists of providing financing for the construction of a new residential structure on property either already owned by the borrower or purchased concurrently with the loan closing. Construction lending takes two primary forms: one closing or two closings.
A one-closing construction loan combines the construction financing into the same loan as the permanent mortgage financing. There is a single closing transaction before construction begins where a single set of fees and closing costs are collected from the borrower. During construction, borrowers pay a monthly interest payment based on the amount of construction funds used to-date (construction funds are accessed through “draws” from the lender) along with an escrow payment for real estate taxes and insurance, if required. Once construction is complete, the loan will convert to the permanent phase and the borrower will begin making a traditional principal and interest payment to include an escrow payment for taxes and insurance, if required.
A two-closing construction loan involves two separate loans: one used only to fund the construction of the residence and associated costs (and possibly lot acquisition) and one for the permanent mortgage financing. The construction loan closes before construction begins while the permanent loan closes after construction is finished. Because two-closing transactions involve two separate loans there are two sets of fees and closing costs collected from the borrower, one set at each closing. Once construction is complete, the permanent loan will close to pay off the construction loan.
Rehab Loans (Renovation Loans)
Renovation lending consists of providing financing for the purchase or refinancing of an existing residential structure along with funds for renovation, rehabilitation, repairs, remodeling or energy improvements to the residence to meet the needs of the borrower or to bring the home up to minimum property standards. This is accomplished with a single closing transaction prior to the start of renovation work and involves a single set of fees and closing costs.
A renovation loan is different from construction financing in that the loan is fully disbursed at closing with renovation funds held in a renovation escrow account. The borrower pays a standard principal and interest payment (plus escrows for real estate taxes, hazard insurance and mortgage insurance, if required) beginning with the first payment.