Construction Loan
A Residential Construction Loan is a short-term loan used to finance the construction or renovation of a home. Unlike a traditional mortgage that provides a lump sum for a completed home, a construction loan is disbursed in stages as construction progresses. Once the home is built, the loan is typically converted into a permanent mortgage or paid off.
Key Features of a Residential Construction Loan
- Short-Term Financing – Usually lasts 6 to 24 months, covering the construction period.
- Draw Schedule – Funds are released in phases (draws) based on completed milestones.
- Interest-Only Payments – Borrowers often pay interest only during construction.
- Higher Interest Rates – Typically higher than traditional mortgages due to increased lender risk.
- Conversion Options – Some loans automatically convert into a permanent mortgage (construction-to-perm loan), while others must be refinanced.
Types of Residential Construction Loans
- Construction-to-Permanent Loan
- Covers construction costs and automatically converts into a traditional mortgage after completion.
- Reduces closing costs since it requires only one loan application and closing.
- Construction-Only Loan
- Covers only the construction phase and must be paid off or refinanced into a mortgage once the home is built.
- Requires two separate loans and closings, increasing costs.
- Owner-Builder Loan
- Designed for homeowners who act as their own general contractor.
- Stricter qualification requirements, as lenders prefer experienced builders.
- Renovation Loan (e.g., FHA 203(k), Fannie Mae Homestyle)
- Used to renovate an existing home rather than build from the ground up.
- Funds can be used for repairs, additions, or remodeling.
Advantages of a Construction Loan
✔ Flexible Funding – Borrowers can access funds as needed for each stage of construction.
✔ Custom Home Building – Allows homeowners to design and build a home to their specifications.
✔ Interest-Only Payments – Helps manage cash flow during construction.
