What is a Construction Loan?

home construction loan

What exactly is a construction loan you ask? A construction loan is a short-term loan that is commonly used to help pay for the construction of a home or other real estate projects. It is usually taken out by the builder of the project to help cover the costs of a project before obtaining other long-term funding. Construction loans have a higher interest rate than that of a traditional mortgage.

What is a Construction Loan?

As stated above, construction loans are typically taken out by the builder of a project or in some cases a homeowner who wants to build the home of their dreams. These loans are short term loans, only lasting one year or less. Once the construction is completed, the loan can be refinanced into a mortgage loan. The financier may also try to obtain a new loan to pay off the construction loan; this is called an “end-loan” in most cases. In most cases, the construction loan must be paid in full before the end date of the construction project.

How Does a Construction Loan work?

In an instance where the loan is taken out by a borrower with the intention of creating their dream home, the lender or bank might state that they will only pay the funds directly to the construction company. The loan payments may come in installments throughout the building contract instead of all at once at the beginning of the said project.

How to Get a Construction Loan

These types of loans may be taken out to finance the rehabilitation and restoration projects of houses as well as to build new custom-designed homes. Keep in mind that most lenders require a 20 percent to 25 percent minimum down payment on construction loans at the beginning of any given project. If a borrower has a limited credit history, obtaining a construction loan will be challenging.

Since the house is not yet built, collateral is considered limited. This can pose an issue when seeking loan consent from a potential lender. In order to get construction loans, the borrower must supply a “blue book”. A blue book is a detailed list of construction steps.

Construction loans are most typically offered through credit unions and/or regional banks. Local banks and credit unions usually know the housing market in any given area and therefore are more comfortable granting construction loans to those in their communities.