Building a home is the perfect chance to personalize your space- but it can be quite expensive. This is where construction loans come in handy. A construction loan provides the funds needed to purchase the land and materials/labor for building a house.

There are several types of construction loans to choose from and the application/approval process is much more complicated than a traditional mortgage. In this article, we’ll explain how construction loans work.

What is a Construction Loan?

Construction loans are short-term funding options used to cover the cost of building a house. They may cover things such as purchasing the land, drafting plans, obtaining permits, and paying for labor/materials. These funds can be used to access contingency reserves if the project ends up costing more than expected or interest reserves for those who don’t want to make interest payments during construction.

How Do Construction Loans Work?

A construction loan allows a future homeowner to purchase materials/labor to build a home. This money can also be used to purchase property- but if you already own the property, you might be able to use it as collateral.

Typically, construction loans are issued for 12 to 18 months and in some cases will convert to a traditional mortgage when construction is complete. The application and approval process is more complex since the loan isn’t secured by a completed house. You will need to provide your lender with architectural plans and allow them to examine your financial standing. Finally, you may be asked for a timeline and budget.

Once approved, you don’t receive the funds- the lender makes payments directly to the builder as the various stages of construction are completed. Construction loans act as a line of credit. Draws are made based on the timeline and an inspector will be sent out to check the status before payment is made.

In most cases, you’ll only make payments on funds as they are issued, not on the entire amount. Depending on your lender, you might also be able to convert the loan into a mortgage once construction is complete. If not, you can apply for a mortgage to pay off the construction loan.

Types of Construction Loans

There are several types of construction loans available:

Construction to permanent loan
Construction only loan
Owner-builder loan
Renovation loan

Requirements for Construction Loans

Before you get the financing, you’ll need to be approved. To be approved for a construction loan, you will need:

Good to excellent credit
Adequate income to pay the loan
Low debt-to-income ratio
20%+ down payment
Project/construction budget approval
Builder/general contractor approval

Choosing a Construction Loan Lender

There’s a lot that goes into choosing a construction loan lender, and it’s easy to get caught up in the details. Contact Porter Capital Group for help with your construction loan needs.