Construction and Refinance Home Loan—the Difference


Many people, including some lenders, are confused about the difference between a construction and refinance home loanThe refinance home loan is what you would apply for if you wanted to rebuild or add to an existing structure that is on its original foundation.  The type of renovation can be something as simple as renovating or updating your bathroom or kitchen or as complex as tearing out the entire structure and installing all-new plumbing, appliances, paint, and more inside the existing structure.  One thing that does fall under this type of loan that many might not think would be adding a new foundation to the one already there to add on an extension of the home.

A construction loan is what you would need if you wanted to build from the foundation up to make a new structure.  You can start with the ground where the older structure was torn down or a new lot.  If you are using the old lot where you tore down the existing structure, you will also have to dig up the old foundation and have a new one poured for the new structure to sit on if you want a construction loan.

Another difference between the two types of loans is the rates.  Generally, they are the same for both types of loans but there is one big difference between them.  That is the loan-to-value calculation that will be used to determine how much you can borrow for your project.  This calculation will be different for the main two transactions, which are:

  • Refinance—this type of transaction will allow for up to 80% of the After Improved Value, which is what it will be valued at after the project is completed.  Most of the time, this will allow almost no out-of-pocket expenses, which can be included with the loan for the borrower.
  • Purchase—this transaction will allow up to 90% of the construction price and purchase price.  The purchase price percentages will vary if the loan is above $850,000.

One important document that is used for both a refinance home loanand a construction loan is the cost based-line item.  It is done on a spreadsheet so that everyone will know what the total cost is at stage-by-stage.  It will be used once the drawing process starts and you start to request money for what is being done and what has been completed.  This will help everyone be on the same page and know what is getting paid and when it was paid. 

When you are applying for a construction loanor a refinance home loan, make sure that you have everything written down that you want to do before you visit a lender to apply for the loan. 

Conclusion

If you are unsure which loan to apply for, the lender should be able to help you decide.  You can also hire a builder or contractor to help you decide if it would be better to refinance and do home improvements or renovations, or tear everything down and start over.