A construction loan is a short-term financing option designed to cover the cost of building a new home or significantly renovating an existing one. Unlike a traditional mortgage, which provides a lump sum upfront, a construction loan releases funds in stages as the project progresses.
Construction loans are typically structured around a draw schedule, where funds are disbursed at key phases of the build—such as foundation, framing, and final completion. Before each disbursement, the lender may require an inspection to ensure the work has been completed properly.
During the construction phase, borrowers usually make interest-only payments based on the amount of money that has been drawn, not the full loan amount.
1. Construction-to-Permanent Loan
This is the most common option. It starts as a construction loan and automatically converts into a traditional mortgage once the home is complete. This means only one closing and fewer overall fees.
2. Stand-Alone Construction Loan
This loan covers only the building phase. Once construction is finished, the borrower must apply for a separate mortgage to pay off the construction loan. This involves a second closing and additional costs.
Construction loans typically have stricter requirements than standard home loans, including:
Construction loans are ideal for borrowers who want to build a home tailored to their needs rather than purchasing an existing property. Working with an experienced lender and builder can help ensure a smoother process from start to finish.
