Construction loans are short-term loans designed to finance the building or renovation of a home. The process begins with application and approval, which is more complex than a traditional mortgage. You’ll need to provide detailed plans, a construction timeline, and a budget. Lenders will review your financial stability and creditworthiness before approving the loan.
Once approved, the disbursement of funds occurs in stages, known as “draws.” These draws are released as specific milestones in the construction process are completed, such as laying the foundation or framing the house. During the construction phase, you typically only pay interest on the funds that have been drawn, meaning your payments start small and increase as more funds are disbursed.
Lenders often require inspections at various stages of construction to ensure the project is progressing as planned before releasing additional funds. There are two main types of construction loans: construction-to-permanent loans and construction-only loans. A construction-to-permanent loan converts into a traditional mortgage once construction is complete, allowing you to avoid a second closing. A construction-only loan covers the construction period only, and once the project is finished, you must secure a separate mortgage to pay off the construction loan. Due to the increased risk for lenders, construction loans typically have higher interest rates than traditional mortgages. Despite this, these loans can be a great option if you’re looking to build your dream home from scratch.
