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Do You Know the Difference Between a Mortgage Loan and a Construction Loan?

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Finding the perfect home can be complex. Building a home has its appeal, you’ll get exactly what you want, but there are some major differences between building and buying. The largest difference between buying a home and building from the ground up is the type of financing required.

When buying a home, a mortgage broker will help you to get a loan for the purchase price of the house. This loan is commonly referred to as a Mortgage. When you decide to buy property and build a new home on it, the loan required for the construction of the new home is referred to as a Construction Loan. While both have to do with a new home, there are a few key differences between them that you should know.

 

What Are They For?

A construction loan only comes into play when you decide to build a new home or building on a property. This is a separate type of loan that’s required by the lender as they take on more risk. There’s no dwelling already on the property so there’s nothing to sell if you default on the loan. With a standard mortgage, there’s less risk to the lender as the value of the home will most likely cover the loan in the event the owner defaults.

Length of Term

A mortgage loan is something that’s paid off over a long period of time, typically 15 to 30 years. A construction loan, on the other hand, is a short-term loan that only covers the period of construction, generally about a year.

Interest Rates

This is where the differences really start to vary. Due to the shorter term and higher risk of Construction Loans, they tend to have higher interest rates. It’s also necessary to understand that construction loans are separated into two types: construction-to-permit loans and stand-alone construction loans. A stand-alone construction loan is completely separate. These require you to apply for a permanent loan, or mortgage, after construction. Since stand-alone Construction Loans are separate from the mortgage, a maximum mortgage rate can’t be locked in during construction. If interest rates change during the construction period when you’re finally ready to look for the best mortgage rates, these are the rates that will be available to you and your mortgage broker.

Construction loans also demand a higher down payment than a standard Mortgage Loan. This is due to the increased risk that the lender is taking on. Generally, a construction loan needs a minimum of 20% down as opposed to the 5-10% of a standard Mortgage.

 

There can be many benefits to building your own home, but it does take a bit more work. A good mortgage broker can help you decide what your best option is. Most financial institutions will lend up to 75% of the original purchase price of a property and up to 75% of the construction costs. This lending percentage can mean high down payments that make building your own home seem impossible. At Great Pacific Mortgage, we lend the 75% for the original purchase price, but we also lend up to 100% of the construction costs. Building your dream home or building does not need to be out of reach. With construction in Victoria booming, make sure you get in touch today if building your dream home is your next move.

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