Understanding Construction Loan Payments: Interest-Only on Draws
Construction loans offer a unique payment arrangement tailored to the specific needs of building projects. Construction loans have monthly, interest-only payments based on the builder's draws, it means that during the construction phase, borrowers are required to pay only the interest on the portion of the loan that has been disbursed. Here’s a closer look at how this process works:
Loan Disbursement and Draw Schedule
- Draw Schedule: Your builder may have a draw schedule, detailing specific milestones and the corresponding payments that the builder will receive upon completion of each phase. Some builders will just simply take draws on a monthly basis based on the work that has been completed
- Inspections: Upon a draw request, we will send an inspector to verify completion of work before approving the draw. This ensures the loan funds are used appropriately throughout the construction process.
Interest-Only Payments
- Disbursement: Approved draws increase the loan’s outstanding balance, which in turn, increases the interest owed.
- Interest Calculation: Borrowers pay interest only on the current outstanding balance of the loan, which can increase with each new draw.
- Monthly Payments: Payments during the construction phase cover only the interest, keeping monthly costs lower until the project is completed.
Transition to Permanent Financing
- Completion of Construction: Once the project is complete and all draws have been made, the loan reaches its full balance.
- Conversion: Many construction loans are designed to automatically convert to a traditional mortgage at this point, ending the interest-only payment period.
- Regular Mortgage Payments: After conversion, borrowers begin making regular mortgage payments, including both principal and interest, according to the terms set at the beginning of the loan.
Key Points to Remember
- Interest Rates: Construction loan interest rates can be higher than those of traditional mortgages, reflecting the additional risk of construction projects.
- Budget and Timing: Close monitoring of the project’s budget and timing is crucial to prevent unexpected increases in monthly interest payments.
- Communication: Effective communication between the borrower, builder, and lender is essential for ensuring the project stays on track and within budget.
This payment structure allows borrowers to effectively manage their cash flow during construction but requires diligent planning and monitoring to keep the project on budget and on schedule.