Tuesday April 20, 2021
If you’re in the market to build a new home, you’re likely going to need a construction loan. A construction loan is a short-term mortgage loan that is used to finance land, materials, labor, and any other costs associated with building a home.
Construction Loans Explained
A construction loan only lasts for the amount of time in which it takes to construct your home, typically around 6 to 12 months. Construction loans work similarly to a credit line, in that you have an approved amount of money to draw on in order to build your home. During construction, the only payments that you’ll be making will be interest only payments, based on the amount that you borrow.
Unlike a credit line, however, you do not have the ability to withdraw the funds as you please. With a construction loan, the loan is typically set up with a pre-determined schedule for advancing the funds, which are then disbursed directly to the contractor to ensure progress is being made on the home as promised.
The funds from your construction loan are typically used for the materials and labor needed to construct your home. The money can also be used to purchase the lot that your home is being built on; otherwise you would need a lot loan to cover that expense.
Since a construction loan will only last for the duration of the building process, your lender will convert it to a permanent mortgage loan once the home is completed.
Types of Construction Loans
There are a few different types of construction loans out there - some have to be paid off once the home is built, and others can be converted into a mortgage that you pay down over time. The two most popular construction loans are the construction-only loan, and the construction-to-permanent loan.
- A construction-only loan means just what the name indicates – your lender will provide you with a loan that covers only the construction costs. Contractors are then paid directly by the lender on a flexible draw schedule. During the construction, you will pay a monthly interest-only payment on the money drawn from the loan. Once construction is completed, you will need to pay off the loan, or refinance it into a conventional mortgage.
- A construction-to-permanent loan is very similar to a construction-only loan, with the main difference being that, at the end of the construction period, the construction-to-permanent loan will automatically convert to permanent financing, thus becoming your mortgage.
Check out our suggested lenders here, where you can prequalify or contact for more details.
Before You Get Started
Since a construction loan is a bit different than your standard mortgage, the process for applying can vary. Just a few things to consider before applying for a construction loan would be:
Know your credit score
As with applying for any type of loan, having good credit is always beneficial. Before applying for your construction loan, be sure to have an idea of where your credit score stands.
Make sure you have a solid down payment
When looking to buy a home, most people typically save up a down payment to put down on the house. A construction loan is no different. Before applying, make sure you ask your lender how much money is required to put down.
Understanding your budget
It’s always a good idea to understand what your budget for your home project is, in order to know how much to expect for your construction loan.