how a construction loan works
construction loans are usually for only one year after construction is complete you can either refinance the construction loan into a permanent home mortgage or get a new loan to pay off the construction loan sometimes called an end loan some borrowers take out a construction loan that is automatically converted to a mortgage loan once the home is completed this is known as a construction to permanent loan the borrower might be required to make interest only payments on a construction loan while the project is underway some construction loans may require the balance be paid off entirely by the time the project is complete 1if a construction loan is taken out by someone who wants to build a home the mortgage lender might pay the funds directly to the contractor rather than to the borrower the payments may be made in installments as the project completes new stages of development construction loans can also be taken out to finance rehabilitation and restoration projects as well as to build new homes 2construction loans allow borrowers to build a custom home but due to the risks involved they have higher interest rates they also require larger down payments than traditional mortgages eligibility requirements for construction loansconstruction loans tend to have tougher credit requirements than conventional mortgage loans because they are not collateralized the home doesn t yet exist so it can t be seized for non payment of the loan construction loans are usually offered by local credit unions or regional banks local banks tend to be familiar with the housing market in their area and are more comfortable making home construction loans to borrowers in their community most lenders require a 20 minimum down payment on a construction loan and some require as much as 25 borrowers will face difficulty securing a construction loan if they have a limited or damaged credit history or too much other debt outstanding to gain approval for a construction loan the borrower will need to give the lender a comprehensive list of construction details also known as a blue book the borrower will also have to prove that a qualified builder is involved in the project construction loans vs owner builder construction loansborrowers who intend to act as their own general contractors or build the home with their own resources are unlikely to qualify for a construction loan these borrowers will have to take out a variant called an owner builder construction loan it can be difficult to qualify for an owner builder construction loan potential borrowers must offer a well researched construction plan that convincingly lays out their home building knowledge and abilities the borrower should also be able to set aside a contingency fund for unexpected costs example of a construction loansay you decide that you can build your new house for a total of 500 000 and secures a one year construction loan from your local bank for that amount you agree on a drawdown schedule for the loan in the first month 50 000 is required to cover costs so you take only that amount and pay interest only on that amount you continues to take funds as needed guided by the drawdown schedule you pay interest only on the total that you have drawn down rather than paying interest on the whole 500 000 for the entire term of the loan at the end of the year you refinance the loan folding the construction costs into a lower interest mortgage on your dream home frequently asked questions faqs 