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Construction Loans

A construction loan is used to finance the construction of improvements on real estate such as homes, apartments, and office buildings. The lender commits to the full amount of the loan, but disburses the funds in payments (draws) during construction. Draws are made to the owner or general contractor for that part of the construction work that has been completed since the previous payment. Before each payment, the lender inspects the work. The general contractor must provide the lender with adequate waivers that release all mechanics' lien rights for the work covered by the payment.

Construction loans generally bear a higher-than-market interest rate because of the risks assumed by the lender. These risks include the inadequate releasing of mechanics' liens, possible delays in completing the construction, or the financial failure of the contractor or subcontractors. Construction loans are generally referred to as short-term or interim financing. The borrower pays interest only on the money that has actually been disbursed. The borrower is expected to arrange for a permanent loan, also known as an end loan or take-out loan, that will repay or "take out" the construction financing lender when the work is completed. Some lenders now offer construction-to-permanent loans that become fixed mortgages upon completion.

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