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Construction Loans How they Work

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Understanding construction loans and how they work, is important when going to apply for a loan. A construction loan is a very simple loan, similar to a balloon note. It only charges interest during the construction process, and the entire amount of the loan is due upon completion of construction. Yes, that sounds scary, but the construction loan is combined with a mortgage loan in most cases. It is a good idea to lock down your interest rate and your mortgage loan, by applying for both at the same time. It is important to remember though that they are two separate loans, a construction loan during the construction, and a mortgage loan after completion of construction.

Construction Loans How they Work: The Beauty

One of the most beautiful things about the construction loan is that all the borrowed money is placed in a bank account, and withdrawn by the contractor, only as it is needed. You only pay interest on the money already used, while the rest waits in the account. Further you only pay the interest, not the principle during the entire term of the construction loan. Your mortgage loan will take care of paying down the principle, after the home is built.

Construction Loans How they Work Options

Construction loans while simple vary a lot in the details, and are based on your needs. They are often called story loans because the loan officer listens carefully to what you need and writes the loan accordingly based on your “story.” Here are some of the variable features.

Construction Loans How they Work Options: Combined with the Mortgage or Not

Sometimes both loans are closed at the same time. This is much more economical and easier. Other times there are two loan closings. It is best to get both loans closed at once to save on closing costs.

Construction Loans How they Work Options: Pay Interest Now or as Part of the Mortgage

Some construction loans require future home owners to make interest only payments, while others just add the interest into the mortgage loan.

Construction Loans How they Work Options: Lock in Mortgage Rate Now or After the Home is Built

This can make a huge difference if interest rates change. Interest rates are currently very low, and it’s a good idea to lock in that rate.

Construction Loans How they Work Options: Down Payment Amount

The amount varies considerably. FHA home builder loans are significantly less, and Veterans Administration loans require no down-payment at all, while some home construction loans require a 30% down-payment. This is why it is vital to talk to your home builder or contractor honestly during pre-qualifying. Pre-qualifying helps the home builder determine what type of loan you need, and which lending institutions might be able to help you get the money you need for construction.

Getting a good loan depends largely on your credit score, work record and income. For the best rates, clean up your credit score, pay off your debits, and pay your bills promptly. Make sure you have held your current job for at least one year, and that your monthly income is at least three times the amount of your future mortgage payment. By understanding construction loans and how they work, you will be able to more easily navigate the loan application process.


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