What is a Construction Loan?

Many people prefer to custom-design their own home, perhaps because it's too difficult to find a home that meets all their needs or because they want a brand-new home. A construction loan is a loan that finances the building of that new home.

Construction loans are different from your standardized mortgages usually underwritten by Fannie Mae and Freddie Mac. They are different because the lender has to know the "story" behind the planned construction before it will be willing to lend money to the borrower.

They also don't pay out all at once. Borrowers usually get between five and 10 draws which coincide with certain stages of construction such as:

  • Pouring the foundation
  • Framing
  • Installing heating and cooling systems, wiring, and plumbing systems
  • Installing cabinets, flooring and fixtures
  • Finishing work (painting, carpeting, etc.)

Construction loans are usually short-term and are converted or replaced by a standard mortgage once construction is finished. Some people get a "construction-only" loan in which only the building of the home is financed. They then have the choice to shop around for another lender and/or a lower rate once the home is occupied.

Others prefer to simply get a "construction-to-permanent" loan in which their construction loan is converted into a standard loan by the same lender, once the borrower has a certificate of occupancy. This saves time and money since the borrower only has to fill out one mortgage application and close once. The type of mortgage the construction loan is converted to is decided on at close.

Rate Lock
Some lenders allow you to lock in your mortgage rate for up to 12 months during construction. This is an advantage because you avoid the risk of rising rates. However, some lenders offer a float-down option which allows the borrower to take advantage of rate dips.

How Much Can You Afford?
To find out how much you can afford to borrow, you must figure out first what it will cost to build. Think about how much it costs to design and build the home; how the build site affects cost (i.e.: if the site is on a steep hill, it may be a financial nightmare to install the septic system); and other such issues.

Once you've estimated the cost of construction, it's a good idea to find out how much you qualify to borrow. Most lenders will offer you a pre-qualification which will give you an idea of how much you can borrow. However, this is not a guarantee since the lender hasn't verified any of your information or committed to the loan amount.

It may be better to get an actual approval. You'll know exactly how much you can spend and whether you can afford to build the home as planned or not.

If you're planning on building a custom home, find out how much you can afford and whether your plans fit within that budget. Also, consider whether you want to shop around for another mortgage once construction is complete or whether you'd rather save yourself the trouble by converting your construction loan into a standard mortgage.

At Alpine Mortgage, we specialize in providing a variety of construction loans. If you have any questions regarding construction loans or are interested in applying for one, call us now at (800) 876-LOAN or click here to have one of our construction loan specialists contact you.

Construction Loan Tools & Advice