A construction loan is a loan used by the owner of a property or soon to be owner of a property where a new home will be constructed, or an existing home will be improved.  The loan is for the owner, not the builder, to use to pay for the home to be built or improved.

Unlike a traditional mortgage where you receive the entire loan amount upfront, a construction loan disburses funds in stages as construction is completed.  You pay interest-only on the balance that you owe during construction with the payment starting out lower and increasing throughout the build process.  After construction is complete, the loan turns into a loan that is like a traditional loan with payments of principal and interest.

Eligibility criteria are about the same as traditional loans.  You’ll need a good credit score, a stable income, a down payment (typically 20-25% of the project cost), detailed construction plans, and a qualified builder.

The amount you can borrow depends on factors such as your income, creditworthiness, the appraised value and the total cost of the project.  Lenders will finance a percentage of the project’s total cost and appraised value.

Disbursement occurs in stages, known as “draws,” which are typically tied to milestones in the construction process, such as completing the foundation, framing, and finishing. You’ll receive funds after each stage is inspected and approved by the lender.  You and your builder will be able to determine when the draws take place.

Before you close on the construction loan, you will select a loan program and lock your rate in.  That will happen before you close your construction loan which is before you start construction.  That program and rate will be in place during and after construction is complete (unless you refinance or modify after).

Your budget is locked in at the time you close the construction loan which is before you start construction.  If the budget goes up during the construction phase, you’ll need to cover the additional costs.

You will generally have 12 to 24 months to complete your project.  If more time is needed, you will need to contact the lender and request an extension.  Additional fees and costs may exist.