How Do Construction Loans Work?


Getting a Construction Loan to Build Your Dream Home

If you are...

  • Struggling to find your dream home on the market
  • Finding your dream home, but ultimately losing to another offer
  • Particular about your next home and its location
  • Looking for a custom build, created just for you and your family’s needs’re likely considering building your next home. And a new home construction loan can help you get it done!

"Building a new home is a great option for people who are struggling to find the right home for their family, especially in today’s market where inventory is low and demand is high," says Angela Stephens, VP Home Lending.

Home Construction Loan Options

What exactly is a home construction loan? It’s a loan used to finance the construction of a residential home – it can cover the cost of the land and the house itself.

When it comes to building a new home, you generally have two loan options:

  1. Construction-to-Permanent Loan: With this type of loan, you borrow money to cover expenses in the construction phase (e.g., land acquisition, labor, materials, and permits). Once the home is completed, your loan converts to a permanent mortgage.

  2. Construction-Only Loan: As the name suggests, this loan provides the funds needed to construct your home. However, you must fully repay the loan upon maturity, usually the estimated time for construction. Repayment can be made in cash or by securing a mortgage to settle the debt.

How is a Construction Loan Different from a Mortgage?

The process of getting a construction loan is similar to that of a mortgage, but with a few twists.

For starters, funds are distributed incrementally in construction loans, unlike mortgages or personal loans that provide a lump-sum payment. The lender releases money for a construction loan in stages as your new home’s construction progresses, typically at significant milestones such as getting necessary permits, preparing the land, and laying the foundation.

Another difference is the repayment structure. Unlike mortgages where you start repaying principal and interest immediately, construction loans usually require interest-only payments during construction. You are obligated to repay interest only on the funds drawn to date until construction is complete.

Additionally, the lender conducts multiple inspections during construction, releasing payments to the contractor (draws) as the work is approved.

Qualifying for a Construction Loan

To qualify for construction loans, certain criteria must be met. These include being financially stable with a low debt-to-income ratio and a sufficient credit score. Additionally, a down payment is usually required. It’s also essential to have a detailed construction plan prepared by a reputable construction company. This plan should include a project timeline and a realistic budget. Lastly, a home appraisal is necessary to ensure the home’s value aligns with the loan amount.

Steps to Getting a Construction Loan

Applying for a construction loan involves steps similar to, but more intricate than, obtaining a mortgage.

  1. Find a licensed builder with proven experience.
  2. Research construction loan lenders and choose yours.
  3. Compile necessary documentation (e.g., a contract with your builder, references, proof of credentials, and personal financial documents).
  4. Start the pre-approval process so you know how much you can afford before you have blueprints drawn up.
  5. Obtain homeowner’s insurance that includes builder’s risk coverage.

Now that you’re armed with knowledge, let’s get started!

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All loans are subject to credit approval.