Construction Loans: Everything You Need To Know

Finding the perfect house can be a fun, yet challenging, endeavor. With so many factors to consider while house hunting – including style, size and location, just to name a few – it can be tough to know where to start. This process can sometimes lead to houses that don’t quite match your dreams.

The good news? Even if you can’t find the perfect home, you can build a new one that is just right for you. To finance this build, you’ll need to know about construction loans.

What Is A Construction Loan?

A construction loan is a short-term loan that covers only the costs of custom home building. This is different from a mortgage, and it’s considered specialty financing. Once the home is built, the owner must apply for a mortgage to pay for the completed home. While we don’t finance construction loans, we can help you when it comes time to convert this to a permanent mortgage.

Construction Loans Vs. Traditional Mortgages

There are several key differences between a construction loan and a traditional mortgage. As mentioned, construction loans are short-term loans, usually no longer than a year in length. On the other hand, traditional mortgages are long-term loans, with terms typically ranging from 15 – 30 years. With a mortgage, the borrower receives the money in one lump sum. Upon closing on the loan, the payments start immediately and consist of both principal and interest.

When you take out a construction loan, you’ll usually make interest-only payments while the construction is being completed. Construction loans also tend to have higher interest rates than most home loans because they are considered to be more risky for lenders.

How Do Construction Loans Work?

You can use a construction loan to cover the total cost of building a home, including the land, labor, materials and permits. The approval process for a construction loan is similar to that of a typical mortgage in that you’ll need to apply and submit documentation to your lender.

Once approved, you’ll be able to start accessing the funds in conjunction with each phase of construction. An appraiser or inspector will check in on the build throughout the construction process so that the borrower can continue to have access to funds.

After the home’s construction is complete, you’ll be issued a certificate of occupancy. Then, your construction loan will likely be converted to a traditional mortgage, and you’ll begin to make payments on the principal and interest.

Types Of House Building Loans

However, there are several other loans available when it comes to home building, from ground-up building to a complete remodel of the entire house. There’s likely a loan out there that’s right for you, whether you’re starting from scratch with a land loan or completely renovating a home.

While we’ll go over several types of financing for building your home, we offer end loans, which are the permanent financing after the home is built.

Construction-Only Loan

This type of loan is short-term and is usually issued for a year. It’s meant to cover only the actual construction period. Why don’t we offer this type of loan? With so many variables like the builder’s cooperation, getting approvals from local municipalities and more, these are considered higher-risk loans.

This means they’re harder to qualify for, and the interest rate will likely be higher than a traditional loan. In addition, if you decide to go this route, you’ll have to pay a second set of loan fees when you apply for a traditional mortgage.

Construction-To-Permanent Loan

Construction-to-permanent loans are a financing option that prospective custom home builders can apply for. Like construction-only, construction-to-permanent financing are one-time loans that fund construction and then convert into a permanent mortgage. During the construction phase, borrowers make interest-only payments.

These types of loans can be much more expensive than traditional mortgages, so if you decide to go in this direction, shop around, compare rates and find the best deal before you pull the trigger. If you’re an active-duty service member or veteran, you may even qualify for a VA construction loan from the Department of Veterans Affairs (VA).

Renovation Loan

Renovation loans, also known as FHA 203(k) loans, can be used for home renovation and are insured by the Federal Housing Administration (FHA). This allows borrowers to both purchase and renovate their new home while still making one monthly payment to cover both costs. Conventional loan borrowers may qualify for these loans through Fannie Mae (HomeStyle Renovation) and Freddie Mac (CHOICE Renovation).

Rocket Mortgage® doesn’t offer this type of loan. However, Rocket Mortgage does offer a cash-out refinance, which can be a different path to getting home renovations done. With a cash-out refinance, you take a portion of your equity and add what you’ve taken out onto your new mortgage principal.

Other options include a home equity loan or a home equity line of credit (HELOC). No matter what you want to change about your home, there are plenty of options to get the financing you need to start swinging that sledgehammer. Rocket Mortgage has Home Equity Loan options. ¹

Owner-Builder Loan

Usually when you build a home, there’s a general contractor who essentially acts as head of the whole operation. They make sure the framing people, the tile people, the wood floor people, the painters and so on all work in coordination to get your home completed (ideally on time and within your budget).

However, some prospective home builders wish to act as their own general contractor, and some banks offer owner-builder loans just for this purpose. These types of loans generally require the borrower to demonstrate through experience, education and licensing that they have the needed expertise to oversee the home’s construction.

End Loan

An end loan is a traditional mortgage loan that a home buyer or home builder (if you’re building your own home) can apply for after the new home is constructed. Unlike the other construction loans previously discussed, these are offered by Rocket Mortgage.

You can get an end loan if construction is complete on the home. One good aspect of an end loan is that the mortgage application for a newly constructed home is the same as it is for any other home. Less complicated is always appreciated when it comes to financing applications.