California Real Estate Broker ExaminationFinancingHard
A developer is planning a large residential project and needs to secure financing. Due to the scale and complexity, the developer is considering a construction loan. Which of the following is a characteristic typically associated with construction loans?
- AThey are often repaid from the sale of individual units as they are completed.
- BThey are usually long-term loans with fixed interest rates.
- CFunds are disbursed in installments or 'draws' as construction progresses.
- DThey are typically unsecured and do not require collateral.
Show answer & explanationAnswer & explanation
Correct answer: C. Funds are disbursed in installments or 'draws' as construction progresses.
Construction loans are short-term, interest-only loans, where funds are disbursed in stages (draws) as construction milestones are met. This minimizes the lender's risk by ensuring funds are used for their intended purpose and align with the project's progress. They are always secured by the property.
Why the other options are wrong
- A. While the proceeds from sales of units ultimately repay the construction loan, the characteristic described (disbursement in draws) is more fundamental to the structure of the loan itself, rather than its ultimate repayment mechanism.
- B. Construction loans are typically short-term (1-3 years) and often have variable interest rates, not long-term fixed rates.
- D. Construction loans are always secured by the property being built, making this statement incorrect.
Construction Loan
A short-term loan used to finance the construction of a home or other real estate project.
- Funds are disbursed in stages (draws) as construction progresses.
- Typically interest-only during the construction phase.
- Secured by the property being built.
- Converted to a permanent mortgage or repaid upon completion/sale.
Memory trick: Construction: 'C'ash 'C'omes in 'C'hunks.