Interest rates are a unique component of the mortgage industry. The rate charged will vary from individual to individual, even with conventional loans. The rate depends on your exact circumstances and the level of risk you provide the lender. Remember, the lender is in the business to make a profit; if he thinks your loan is risky to take on, he will charge a higher interest rate. Because construction loans are risky in general, you can expect construction loan rates to be higher than conventional loans as a whole, but other factors play a role.
Construction Loan Rates: Down Payments Play a Part
Most lenders have a minimum down payment they will allow for a construction loan, but this amount varies by lender. As a general rule, 20% is the minimum, but there are lenders that will provide exceptions to that rule. Typically, the higher down payment you put down, the less risk you pose to the lender, so the lower your interest rate will be. Of course, other factors play a role, such as your credit, income, and debt-to-income ratio, but the down payment plays the most important role as the more you have invested in the process, the more likely you are to make it work in the end.
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The Interest Only Component of the Loan
The construction part of the construction loan is the riskiest part for the lender because most lenders only require you to make interest-only payments during that time. This short-term loan then becomes due in full at the completion of the construction. In order for the lender to make money in the process, the interest rates are typically at least 1% higher than conventional rates during this period. Some lenders will grant exceptions, especially if you put a large down payment outright, though. This portion of the loan is short-term and only lasts during the period that your home is being built and while you are likely paying for housing elsewhere since your home cannot be lived in just yet.
The Permanent Loan Period
Once the loan converts into a permanent loan, whether as a part of the one-step construction loan or as a refinance into a permanent loan, you are given your standard interest rate. This loan rate will vary depending on the type of loan you took out. For example:
- The one-step loan that converts directly into a permanent home loan typically adjusts into an ARM. This means that the interest rate adjusts in predetermined intervals. The initial rate might be slightly lower, but the rate will likely adjust upwards as the loan period goes on.
- A refinanced permanent loan that pays off the construction loan and is a separate process can have any type of interest rate. Some lenders offer long-term, fixed-rate interest for these loans. The key is to lock the rate in before the home is set to be finished but within a time period that you know the home will be done so that you do not lose the rate.
Options to Change the Interest Rate
There are options available to you should you decide to lock in a rate while your home is being built and then interest rates fall. If you have a locked in rate for either type of loan, you can pay to get a lower rate if rates were to fall after you locked it in and while you waited for your home to be built. This process is called the float down rate. It allows you to pay a fee to lock in a lower rate than you already paid to lock in if the rates were to come down. This, of course, adds to your closing costs, but if it saves you a significant amount of money in the long run as you pay your mortgage for the next 30 years, that fee can be well worth it.
You have the ability to shop around for a construction loan, whether for the construction portion or the final loan. If you choose to refinance the construction loan rather than have a converting loan once construction is complete, you do not even have to stay with the same lender – you can shop around with various lenders to see who will provide you with the best rate. Remember to compare “apples to apples” though – make sure the terms and loan amount are identical in order to determine which interest rate is right for you on both the construction loan and the permanent financing.Click to See the Latest Mortgage Rates»