how does a construction loan work

Everything You Need to Know About Construction Loans

Post Author:



Date Posted:

December 28, 2021

Share This:

With low housing inventory still a concern for potential homebuyers, construction loans have become a pathway to homeownership for those who can’t wait for more new homes to hit the market. These little-known loans can be a useful way to to bring your vision to life. Here’s what you need to know about construction loans and different ways you can make your homeownership (or renovation) dreams come true.

What is a Construction Loan?

A construction loan is a short-term loan that is meant to be used for the building of a residential property. Whereas mortgage loans are generally long-term loans that help you finance the purchase of an existing property (by which the loan is secured), construction loans help would-be homeowners finance the construction of their future home. The loan is secured

A construction loan is one type of loan option used when doing renovations or building projects on a residential property. These loans are generally characterized by having high-interest rates and relatively short-term borrowing periods, usually of 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 that a construction loan can be similar to a mortgage is that a down payment may be required. For a construction loan, this helps ensure a lendee’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, provide financial documents like bank statements, and share the plans for the proposed construction.

Keep in mind that different lenders will have different requirements. Depending on your project and personal finances, you may find that a different loan type may better suit your needs, so be open to alternatives and discuss them with a knowledgeable lending partner.

Are There Different Kinds of Construction Loans?

Construction loans aren’t all the same. They come in many forms to meet the needs of each individual homebuyer or homeowner.

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

Read on below to learn all about the different kinds of construction loan options

Construction-Only Loans

This is the most straightforward version of these loans. Essentially, the money lent will cover the entire cost of the building project, but the borrower must pay it back in full at the end of the year-long lending period. 

Construction-to-Permanent Loans

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

Owner-Builder Construction Loans

What makes this version unique is that the person borrowing the money is also the person performing the labor for the building project. It allows both parties to save money on hiring contractors, but lenders are often more hesitant to give out these loans due to the risk and complexity of building a home. 

Renovation Loans

This version offers special rates for homeowners who are just looking to make alterations to an existing home rather than build one from the ground up. These kinds of loans also vary in structure based on the needs of the borrower.

End Loans

If a lender does not offer construction-to-permanent loans, homeowners can receive an end loan. Essentially, the homeowner can use their mortgage to refinance their construction loan once the build is complete. 

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

What Can I Do with a Construction Loan?

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

  • Building materials
  • Compensation for the contractors performing the labor
  • The deed for the land 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 in your best interest, consider whether an alternative loan type may help you improve your current home so you can still achieve your goals.

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

Home Equity Line of Credit

A home equity line of credit, or HELOC, is one of the most common ways homeowners choose to 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 one’s home as collateral. 

Hard Money Loans

A hard money loan is given to borrowers by a bank 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 it should be noted that the interest rates and other features are generally not as favorable with this option.

VA Loans

If you have served in the United States military 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 incredibly low rates and are generally more favorable to borrowers. 

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


So, now that the question “How does a construction loan work?” has been answered for you, you’re 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 the property of your dreams. 

Recent Posts

  • pros and cons of bridge loans

The Pros and Cons of Bridge Loans

It should come as no surprise that the most significant concern today for home buyers is affordability. Inflation has caused rising home prices, and many feel that owning a home is untenable, and mortgage interestRead More

  • fix and flip loans

All About Fix and Flip Loans

Rehabbing homes remains a great source of income because acquiring property has long been a sound investment. However, you’ll require fix-and-flip loans to meet your needs, whether you’re a first-time flipper or a seasoned investor. Read More