Building loans are different from normal home loans because they are usually used to finance a construction or building project of some sort. The lender usually values the project based on how much it will be worth once all construction is complete.
There is a perceived added risk in the process of building loans as not all building constructions are completed on time, or even at all and so a building or construction loan will often attract a higher rate of interest to offset the risk. Many building loan projects, particularly those that are run by owner builders run over time and over budget and this leads to problems with the finance.
An overrun on cost on a building or construction loan can mean that the project runs out of money before it has the chance to reach the final construction value. This can leave the lender in a difficult position as it is difficult to sell an unfinished project and it is almost impossible to sell an unfinished project at close to the value it would be worth once completed. This is a position that lenders (and borrowers) want to avoid if at all possible.
One of the keys to making sure a building loan works successfully is to convince the lender that the final value of the property is significant.
One of the most important ways in which they differ from other types of loans is that they often offer features that make it possible for only part of the loan to be used at the start and the rest pulled down in stages as required.
The ability of building loans to draw down money in stages is of course a really good way to ensure that you are not paying interest on money you don’t yet require. No owner builder would pay a builder the complete cost of the project up front and so traditionally work gets paid in stages.
Staged payment as part of the structure of a building loan can be extremely useful but there are some factors of which you need to be aware. Depending on the type and conditions of the loan it is often a requirement that an inspection be carried out before the funds are discharged.
From the lenders perspective it makes sense to carry out an authorized inspection before each part payments are paid out on a building loan. This is because a lender needs to be sure that each stage of the project is proceeding on track and on budget. If they check before each stage is paid out, it provides some added security.
From the perspective of the person in charge of the building loan, it is important to understand that there can be a delay between a stage of a building being completed and the money for that stage being made available. There are also a number of things that may need to be done to fit the requirements of the lender. An example of this is that many lenders require that that windows are fixed into position before that stage is considered to be completed. The windows and frames may be on site but if they are not fixed into place, the lender may consider that stage of construction is incomplete.
Details like this when working to a tight budget on a building loan can make the difference between whether the project is a success or not. It is another reason why it is vitally important to arm yourself with knowledge before you start and also to enlist an organisation or individual who can help you navigate the various pitfalls and dangers.
In most cases, once the project has been finished, the building loan will be converted into a standard home mortgage as the features that a building loan offer are only required during the actual construction phase.