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Why are interest reserves and contingency funds being added to my requested loan amount into the budget?
The two items most customers do not factor into the cost of the building their new home are interest reserves and contingency funds.
Interest reserves are added to your loan amount to make the monthly payment on your loan. Yes, you read that correctly, you will not have to make a monthly construction loan payment while your home is being built. The payments are made from this interest reserve account and no, it's not free. This reserve is added to your construction loan amount.
Interest reserves were designed for the benefit of the customer. Most people building a new home are either paying rent or have an existing mortgage payment while their home is being built.
The last thing a customer needs is another monthly payment while building. So, banks created the interest reserve account by adding up the estimated interest payments over a 12 month period and add this to the loan amount.
If you do not want interest reserves added to your construction loan amount you can ask to make your own monthly construction loan payment.
Contingency funds are added to the loan amount just in case you need more money to finish building your new home. With all good intentions construction loans tend to have cost over runs. The bank adds 5% to 10% of the cost breakdown and adds this amount to the loan amount just in case you have cost over runs or need better appliances. If you don't need or use this extra contingency fund then it will not be added to your mortgage upon completion of your new home.
So when you apply for a construction loan ask your loan officer to provide you a copy of the estimated construction loan budget. This budget is not usually meant for the customer but an experience construction loan should not have a problem providing this to you.
The budget is created from your costs and includes every cost within the loan including land balances, closing costs, interest reserves, contingency and bank fees.
Call me and I will provide one to you via email.