Construction Loans

What Is a Construction Loan?

A construction loan, also called a renovation loan, is a short-term loan with a higher interest rate than a conventional loan that provides you with the funding to either remodel your home or have one built. The higher interest rate is due to the lack of collateral your home offers in a conventional loan. Therefore, the lender will see the investment as a higher risk. The loan term is usually one year, during which a new home must be completed and a certificate of occupancy issued. Due to the short timeframe, the lender will typically ask for a construction timeline, plans, and your expected budget.

Construction loans typically have an adjustable interest rate based on the current prime rate. Once approved, the payments will be made on a schedule, usually determined by the planned construction schedule. This is another way they are different from conventional loans, which are paid out all at once. The lender will typically have an appraiser or inspector come out to check on progress. If additional funds are deemed necessary, the lender will pay the costs directly to the construction contractor. The loans are meant to cover land costs, labor, building materials, and permit fees. Please note that home furnishings are not usually eligible for a construction loan, but permanent fixtures of the property like appliances and landscaping are.

Sometimes, homeowners can choose to convert the construction loan into a conventional mortgage once everything is done. This is called a construction-to-permanent loan. How feasible this will be for you (and how expensive it might be) depends on the type of loan you take out.