Owning a house appeals to everyone, and it is one of the aspired dreams of most individuals to have their own house. However, not everyone likes to fulfill their dreams by buying a readymade house. Some prefer buying land and constructing a home on it. Construction of the home is not an easy job; the skyrocketing cost of construction makes it difficult for an individual to pay for the construction, to add to the agony is increasing manpower cost. That’s where the construction loan comes into the picture. It helps an individual to finance the construction of the home, thus helps in bridging the gap by providing the required amount for construction. Estimation of overall home loan EMI can also turn out to be helpful.
Today, we will understand the nitty-gritty of the construction loans, if you continued with us you will be well versed with the pros and cons of the construction loans. Further, you will get a basic idea about whether the construction loan will suit you or not.
Let’s get started
What are construction loans?
As discussed earlier, construction loans are the loans used for financing the construction of the house, unlike the traditional home loan where the new house is purchased and the loan is provided based on the market value of the loans. The construction loan is based on future value or the value after the completion of the house. The total cost of the construction loans is not disbursed in one go instead it is given in instalments to the builder when he completes the previous phase of construction. The instalment here is known as draws.
Pros of construction loans
1. Saving on interest
The builder is not provided the complete funds for the construction, and he receives the loan amount as and when he completes the previous construction phase of construction. This process is actually beneficial for the borrower as he is expected to pay the interest in an amount which is disbursed. Thus it helps in saving money on interest.
The construction loans offer way more flexibility to borrowers in terms of loan terms. Banks and financial plans seek special plans and for the project and offers flexibility with certain other guidelines too.
The added scrutiny by the bank may look like a deterrence, but it is a blessing in disguise and force the builder to complete the project in the budget and schedule.
Cons of the construction loans
Every coin has two sides, and the construction loans are not merely beneficial, but they have a few disadvantages too:
1.Higher credit score
Most banks and financial institutions follow a rigid structure and count in various factor for approving a construction loan. So it becomes difficult for many individuals to qualify for this loan. For example, Most banks have a set criterion of minimum credits score of 680.
2.Higher interest rate
Interest rate is one of the most crucial ways of judging whether the loans are good for an individual or not. Bank charges way higher interest rates for home construction loans. The higher interest rates reduce the allure of home loans.
3.High-risk factor and limited tax benefit
There are various factors associated with home construction loans like the builder’s honesty and some external factors which make this credit option high risk-prone. Unlike traditional home loans where one can avail tax benefits on both interest and principal amount, for a home construction loan one will get tax benefits only for the interest paid if the construction activity is not complete.