Understanding Construction Loans


If you can’t find a home that meets all your wants and needs, building a brand-new home may be the answer. But how do you get a mortgage on a building that doesn’t exist yet? Financing the construction of a new home is a bit different than taking out a mortgage on an existing property. Here’s a look at how construction loans work and what to expect if you’re considering a new-home build.

Construction loans are short-term loans, usually for a term of about one year. The loan amount is calculated from the estimated value of the finished home. Construction loans cover the costs of purchasing the permits, materials, and labor to build your new home. The cost of the land to build on may also be included in some cases. Appliances, permanent fixtures, and even landscaping can generally be paid for with a construction loan. For you to qualify, construction loans require higher credit scores and larger down payments than a traditional mortgage, plus a detailed building plan including blueprints, a timeline, and an estimated cost breakdown that your architect or builder will give you. As your home is being built, your lender will check on the progress of construction, helping to keep things on schedule and within your budget.



Instead of getting a lump sum of cash paid to you so that you can then turn around and pay your builders, the payments (also called draws) are sent directly to your contractor(s), taking that responsibility off your hands. Draws are made in installments on a regular schedule based on your estimated timeline and budget. Before each draw is released, your lender will send an appraiser or an inspector to the construction site to make sure things are going according to plan. During the construction phase, you’ll only need to make interest payments on the loan amount. Paying down the loan principal starts upon completion of your home, when you’ll need to change to a standard mortgage. Depending on the loan program you select, your construction loan may automatically convert to a traditional mortgage, or you’ll need to take out a new one.

There are several loan programs designed specifically for people who are building a new home. We can set up a call to go into more detail on each, but for now, here are the basics:


Construction-only loan

With a construction-only loan, if you can’t pay off the loan in a lump sum upon completion of your home (most people cannot), you’ll need to take out a mortgage to pay it off. The construction-only loan will fund your build, and the new, standard mortgage will pay off your construction loan. You end up with two separate loans and two sets of closing costs.



Construction-to-permanent loan

Sometimes referred to as an all-in-one or a one-time close loan, a construction-to-permanent loan will convert from a construction loan to a standard, long-term mortgage upon completion of your home. Like with any mortgage, you’ll then make payments on the interest and the principal. No additional closing costs or fees need to be paid.



Lot loan

A lot loan is specifically for purchasing the land you want to build on. A separate loan for construction will be needed. A lot loan is not always necessary as some construction loans include the cost of the land.

Building a new home is a huge project, but with the right loan and the right lender, it can be a smooth process that gets you into the home you’ve always wanted.

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