Construction loans are usually taken out by builders or a homebuyer custom-building their own home. They are short-term loans, usually for a period of only one year. After construction of the house is complete, the borrower can either refinance the construction loan into a permanent mortgage or obtain a new loan to pay off the construction loan (sometimes called the “end loan”). The borrower might only be required to make interest payments on a construction loan while the project is still underway. Some construction loans may require the balance to be paid off entirely by the time the project is complete.
Borrowers who intend to act as their own general contractor or build the home with their own resources are unlikely to qualify for a construction loan. These borrowers will have to take out a variant called an owner-builder construction loan. It can be difficult to qualify for these loans. Therefore, potential borrowers must offer a well-researched construction plan that convincingly lays out their home-building knowledge and abilities. The borrower should also include a contingency fund for unexpected surprises.
Most lenders require a 20% minimum down payment on a construction loan, and some require as much as 25%. Borrowers may face difficulty securing a construction loan, particularly if they have a limited credit history. There may be a shortage of collateral because the home is not yet built posing a challenge in seeking approval from a lender. To gain approval for a construction loan, the borrower will need to give the lender a comprehensive list of construction details (also known as a “blue book”). The borrower will also have to prove that a qualified builder is involved in the project.
Construction loans are usually offered by local credit unions or regional banks. Local banks tend to be familiar with the housing market in their area and are more comfortable making home construction loans to borrowers in their community.
