Construction loans are relatively simple in theory, but tend to be much more complex in implementation. To help your budget calculations, this article will explain how they work and how to calculate construction loan payments during the construction period. Most construction loans require interest only payments during the construction time frame and will adjust to include principal, also, after full dispersal.
Review your construction loan disbursement schedule. Some lenders prefer - or may mandate - simplicity (it's less work for them). This may or may not be good for you, too. They may establish only three equal disbursements (30%) with a 10% "hold back" to be paid after a final inspection. Other lenders will allow you to set a schedule that works for you and may include five, six, or more disbursement amounts. This gives you access to funds to pay subcontractors and other charges more frequently. Understanding your disbursement schedule helps you estimate and/or calculate your coming construction loan payments.
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Learn when construction loan disbursements are posted to your outstanding balance and when payments are due during the construction period. For example, a disbursement made during the last three to five days of a given month may or may not be posted to your loan balance and require interest thereon for your next payment. The loan terms regarding disbursement posting affect your loan payment calculation.
Divide your construction loan interest rate by 365 (or 360, if your lender uses 30-day months for calculation). The resulting number (percentage) is your "per diem" (daily) interest rate. If you have a variable interest rate per your construction loan note, always verify the current month's rate before calculating your per diem rate.
If there have been no new disbursements in the current month, take your outstanding balance at month's end and multiply it by your per diem interest rate and then by the number of days in the current month (or 30 if your lender uses equal days months). An interest-only construction loan will require this payment as it shows interest due based on your loan balance and the number of days you had "use" of these funds.
If you had a balance on day one of the month and had another disbursement during the month, calculate your construction loan payment by doing the following. Multiply your outstanding balance on day one by the per diem rate for the total days in the month. Multiply the new disbursement by the per diem rate and the number of days between disbursement date and the end of the month. Add the two interest charges together, and you've calculated the expected construction loan payment for the current month.
After the construction period ends (usually six months), your lender should provide you with a payment schedule going forward that includes principal and interest. Some lenders will convert your construction loan to "permanent" financing - a mortgage loan. Others, will expect you to obtain a new mortgage loan with your current or another lender as quickly as possible so they can "retire" the construction loan off their books, since it was always meant to be temporary financing.
Keep your own running total of disbursement amounts and dates so you can verify that your lender's records are correct. If you are unsure of your per diem interest rate, ask your lender for verification. If the rates and amounts differ slightly (by a few minor points or pennies), don't worry as the number of places to the right of the decimal point may differ between you and the lender calculations.
If you need to get permanent financing shortly after the construction period ends, don't wait until the end of the project to make a mortgage loan application as it could take up to 60 days to close the new loan. Assume nothing in addition to the specifically stated terms in your construction loan note regarding disbursements, interest rates, payment due dates, and appropriate calculations to arrive at payment amounts.