Home Construction Loan 101 – Breaking Down the Basics
Updated on January 8, 20195 mins read
Are you curious about how banks disburse home construction loan amount compared to standard home loans? Did you know that there’s something called ‘Pre-EMI’? Are you aware of the prerequisites for a home construction loan?
Discover the various facets of this home loan product and get answers to all your questions in this post.
Building a Custom Home with Construction Loan
Self-building your own house as opposed to buying a pre-constructed house is a great option for those who have access to the right plot and perfect location. While exciting and adventurous, constructing a house from scratch is a strenuous process that requires a great amount of time, money and effort. To ease this process, many bank and financial institutions offer monetary assistance in the form of home construction loans.
You can consider applying for a home construction loan, if you have a plot of land, where you can either build a home for yourself, build a property to give it on rent or sell it for a profit.
If you are thinking about applying for a home construction loan, we are here to help.
Home Construction Loan Requirements
The basic eligibility criteria, and documentation list is same as any other home loan. A borrower has to submit proof of income, identity, and employment, which would allow the lender to assess the borrower’s loan repayment capacity.
In case of construction loans, lenders have a tight control over application of credit and diligently monitor the borrower’s property documents and project estimates. Banks and financial institutes are tight with underwriting and documentation when it comes to sanctioning credit for self-construction of a house.
Below are the two important factors that lenders need to pay attention to before applying for a construction home loan:
Get your property documents ready – Since the property purchased acts as a security and is mortgaged to the bank until the loan is repaid, lenders thoroughly scrutinize the property documents. Sales deed, legal status of the plot, approved plan and NOC from the municipal authorities are a few documents that a borrower would have to submit.
Get your construction plans ready – Submitting a tentative construction plan that is subject to change would lead to loan application getting rejected. Banks ask for a detailed construction plan during the loan approval process. The plan must clearly include details such as floor plans, boundaries, purpose of the property, value of the property, suppliers, inventory, total cost, time period, and projected profits (in case of resale/rent).
Things to Remember About Home Construction Loan
Owing to the inherent nature of this home loan product, the approval and disbursement process is slightly different from the other home loans. Primarily because of the higher default risk associated with it. The risk factor is higher for an independent yet-to-be constructed home in comparison with pre-constructed or under-construction project of a professional builder.
Here are the things that a lender must know about home construction loan:
Loan amount disbursement – Credit of an approved home loan is disbursed once the initial down payment is made. Lenders demand a down payment amount of 20% of the construction cost/property value before disbursing the loan amount. This percentage might differ from lender to lender. In the case of regular (for pre-constructed or under construction properties) home loan, the credit is disbursed at one go by the lender. But in the case of construction loan, the approved amount is always released in instalments. The progress of construction, size of the loan and loan to value ratio (LTV) determines the instalment size.
Slow progress would affect disbursement – Lenders often have pre-decided levels of construction progress for loan disbursement. The most common milestones are foundation level, lintel level, concrete work and then the final level. The speed of construction has a direct impact on the loan amount disbursement. The lender has the authority to halt the payments, if the construction activity is delayed or hanging.
Borrower can’t alter the construction plan – Loan applicants often wonder if they can take a construction loan from a bank to build two floors and then construct only one or vice versa. The simple answer is, no! Lenders have a team in place to keep a constant watch on construction progress. Any deviation from the actual plan submitted during the application process, be it extension or reduction, might force the lender to freeze the loan and stop disbursement.
Cost of interiors is not included in the loan – Construction loan only covers the cost of permanent features of building a home. Therefore, any expenses incurred while setting up the interiors, furniture, plumbing, lighting and other such elements, would have to be paid by the borrower. Although, there are other home loan products like Personal Home Loan or Home Improvement/Renovation that could come in handy for financing the interior work expenses of your dream home.
Pre-EMI Interest Payment – Construction home loan applications are required to pay Pre-EMI during the construction period of the property. This amount is the applicable interest on the loan amount disbursed and excludes the actual EMI amount and loan tenure. Once the property is constructed and final loan amount is released, the actual loan tenure starts.
Explore Your Options
In India, ICICI, HDFC, Bajaj Finserv, Aadhar and PNB Housing are a few of the many banks and financial institutions that offer home construction loans. Each of the lenders has set different loan amount limits, which is heavily dependent on the value of the property and repayment capacity.
For instance, Aadhar Housing Finance offers loan up to Rs. 1 crore, not exceeding 70% of the plot cost or 80% of construction cost. Pradhan Mantri Awas Yojana (PMAY) with 6.50% interest subsidy is a great scheme for people looking for affordable housing loan options.
With thorough planning and a good builder, a borrower can increase the chances of his/her application getting approved with favourable terms. Research extensively online and ask around for recommendations before deciding on the final product. If you need any assistance in understanding home construction loan options, getting introduced to best lenders or creating a rejection proof application, we suggest that you reach out to a home loan advisor/expert.
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