What Are Construction Loans?

For those who built a home rather than bought an existing one, you might notice that traditional mortgages aren’t applied. Of course, it’s a difficult endeavor to set out on to try and figure out how to build a house by yourself; it’ll be a difficult road, for sure, but it’ll be way more worthwhile in the end.  Instead, you’ll likely have to get a construction loan.

But what is a construction loan, you may be wondering? They are high-interest, short-term loans that cover the costs of building or rehabilitating a home. They’re based on the projected value of the home once the construction is complete, rather than the home’s condition in comparison to other recent sales. Traditional home loans are based on the fair market value of the home and are determined based on the condition the home is in.

Here are the three different types of construction loans you can choose from:

  1. Construction to permanent loans: if you have definitive construction plans for your home and have the timelines locked in place then this is the right loan for you. The bank pays the builder through the loan as the construction is finished. The cost is then turned into a mortgage. It will allow you to lock in the interest rates at the closing of the loan and finishing of construction, allowing for steady payments in your loan.
  2. Construction only loans: these loans need to be paid off in their entirety once the construction on the home is completed. For those who have a larger stockpile of cash to play around with in their renovation and construction process, then this is the best loan option for you to look into. It’s also good for those who are sure that any proceeds from a selling a current home will then come through to allow you to pay and build another home instead.
  3. Renovation construction loans: for those who have purchased a fixer upper, then this is the best construction loan for you. Fixer uppers are exactly how they sound: it’s a home that’s fallen into disrepair so it’s something you likely purchased at a lower price than you would a home that’s in a good state. For these types of loans, there are often government programs in place and the projected cost of the renovations will be tied up in the mortgage with the purchase price.

Image via Mortage Calculator.