What Happens When a Construction Loan Goes Into Default?

Construction loans are a powerful tool to help turn your vision of a dream home or renovation into reality. However, like any loan, they come with responsibilities—and when those responsibilities are not met, default can occur. But what does that mean for you as a borrower?

Understanding How Construction Loans Work
A construction loan typically has a shorter term than a traditional mortgage, with disbursements made in stages as your project progresses. These payments, known as draws, are meant to align with milestones in your build—foundation, framing, roofing, etc. During the construction period, borrowers usually make interest-only payments on the amount disbursed.

What Causes a Default?
Default can happen for several reasons: missed payments, failure to complete the project on time, using funds inappropriately, or even halting construction altogether. When a borrower defaults on a construction loan, it sets off a series of actions to protect the lender’s investment and may have serious consequences for the borrower.

Steps Lenders May Take
First, the lender may suspend future draw payments. This can effectively pause the project if you or your builder are relying on those funds to move forward. Next, the lender will usually issue a notice of default. At this point, there’s often a chance to resolve the issue—by catching up on payments or addressing the cause of the delay. Open communication is key; the sooner you engage with your lender, the better your options.

Consequences of Loan Default
If the default isn’t resolved, the lender may initiate foreclosure proceedings. This means they could take possession of the property, including any improvements already made, and sell it to recover the loan balance. In addition, your credit score could take a significant hit, impacting your ability to secure future financing.
There may also be legal action if misused funds or contractual violations are involved, especially if subcontractors go unpaid and file liens on the property.

Working With Your Lender
At our company, we understand that life and construction projects don’t always go as planned. That’s why we emphasize education, transparency, and strong relationships with our borrowers. If you’re struggling or anticipating delays, we encourage you to reach out. In many cases, we can work together to restructure draw schedules, adjust timelines, or find other solutions to help keep your project on track.

Default is not the end, it is a signal that something needs to be addressed. By staying proactive and maintaining honest communication, you’ll put yourself in the best position to navigate challenges and move forward confidently.