What Is A Construction Loan?

What Is A Construction Loan?
6 min read

What Is A Construction Loan?

A construction loan is a short-term loan intended to be used for the construction of a residential property. While mortgage loans are generally long-term loans that help you finance the purchase of an existing property (whereby the loan is secured), construction loans help prospective homeowners finance the construction of their future home. . The loan is guaranteed

A construction loan is a type of loan option used when doing renovations or construction projects on a residential property. These loans are typically characterized by high-interest rates and relatively short loan terms, usually just one year.

Construction loans can also be used to build commercial projects.

How Does A Construction Loan Work?

Construction loans differ from mortgages in many ways. In addition to their short terms, they also tend to have higher interest rates.

Who Is Eligible For A Construction Loan?

One way a construction loan can be similar to a mortgage is that a down payment may be required. For a construction loan, this helps ensure the lender's commitment to the project.

In addition to being able to cover a down payment, a prospective borrower may also be required to have a minimum credit score, and provide financial documents such as bank statements, and share plans for the proposed building.

Please note that different lenders will have different requirements. Depending on your project and your finances, a different type of loan may be better suited to your needs, so be open to alternatives and discuss them with an experienced lending partner.

Are There Different Types Of Construction Loans?

Construction loans are not all the same. They come in many forms to meet the needs of each buyer or homeowner.

So how do you know which type of construction loan is right for you? It all depends on your situation.

Read below to learn all about the different types of construction loan options.


This is the simplest version of these loans. Essentially, the borrowed money will cover the entire cost of the construction project but must be repaid in full by the borrower at the end of the one-year loan period.


Unlike a construction-only loan, these loans do not necessarily have to be paid in full at the end of the loan period. Instead, once the year is up, the loan becomes a permanent mortgage and the borrower can continue to make payments through this channel as needed.


What makes this version unique is that the person who borrows the money is also the person who does the work for the construction project. It allows both parties to save money on hiring contractors, but lenders are often more hesitant to make these loans due to the risk and complexity of building a home.


This version offers special rates for homeowners just looking to make alterations to an existing home rather than build one from scratch. These types of loans also vary in structure depending on the needs of the borrower.


If a lender does not offer construction-to-permanent loans, homeowners may receive a final loan. Essentially, the homeowner can use his mortgage to refinance his construction loan once construction is complete.

Not all lenders offer these types of loans. Contact us and we can help you determine which type of loan may be best for your situation.

What Can I Do With A Construction Loan?

Construction loans will cover all major expenses associated with building a new home or renovating an existing property. The main tangible items they will pay for are:

  • Construction materials
  • Compensation for contractors performing the work
  • The deed to the land it is being built on (if not already owned)
  • Any permits required by the city to complete the project.

What Other Options Do I Have Besides Construction Loans?

If you find that a construction loan isn't right for you, consider whether an alternative loan type can help you improve your current home so you can still achieve your goals.

These are three of the most common alternatives to construction loans that you may want to consider.


A home equity line of credit, or HELOC, is one of the most common ways homeowners borrow money to invest in home construction projects. These loans allow you to borrow against the value of your property or your mortgage. They offer very good interest rates, but there is a certain degree of risk involved with using the house as collateral.


A bank makes a hard money loan to borrowers using some of the borrowers' tangible assets as collateral. Like a home equity line of credit, recipients can borrow against the value of their home or property but note that interest rates and other features are generally not as favorable with this option.


If you have served in the United States armed forces and are eligible for veterans benefits, you may qualify for a VA home or construction loan. These are similar to traditional construction loans, but offer meager rates and are generally more favorable to borrowers.

These loans require no down payment or private mortgage insurance, so eligible veterans should consider this financing option seriously.


So now that the question “How does a construction loan work?” has been answered by you, you are probably ready to take the next step. When you're ready to discuss your options, contact our team at Associates Home Loan and get the financing you need to finally build your dream home.


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