Construction Loan
What Is a Construction Loan?
A construction loan is a short-term loan used to finance the building of a new home or major renovation project.
Unlike a traditional mortgage that finances a completed property, a construction loan funds the building process in stages.
It typically converts into a permanent mortgage once construction is complete.
Why It Matters in a Mortgage
Construction loans:
- Provide financing for land and building costs
- Require detailed building plans and contractor approval
- Involve higher oversight and documentation
Because the property does not yet exist, lenders face higher risk. As a result, underwriting is more stringent, and interest rates are often higher than traditional mortgages.
How It Works
- Borrower submits construction plans and budget.
- Loan is approved based on projected value after completion.
- Funds are released in draw stages as construction progresses.
- Loan converts to permanent financing or must be refinanced.
During construction, borrowers often make interest-only payments.
Construction Loan vs. Traditional Mortgage
Construction Loan → Funds building process
Traditional Mortgage → Finances completed home
The risk and structure differ significantly.
FAQs About Construction Loans
Is a down payment required?
Yes, and it is often higher than a traditional mortgage.
Can construction loans convert automatically?
Some are structured as “construction-to-permanent” loans.
Are interest rates higher?
Typically, due to added lender risk.
Related Terms
