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What is a Construction Loan?

Updated: Nov 30, 2022

So you’ve made the decision to build a new home; congratulations! The list of things you will have to do will be a challenge and an immense learning experience. At the top of your list should be determining your budget and if you will need a loan, getting a loan approved so you can get started. You may not be aware that you can’t get a regular mortgage for a home that isn't built yet. When you are building you need a special loan called a “construction loan.” So let’s discuss what this loan is and how it works.

A construction loan is like a line of credit up to the full cost of the home. You don’t get the full amount when the loan closes as the lender will only pay deposits to contractors and then full payment when each phase is completed. The lender may also require an inspection of each phase completion before payment is made. You will pay interest only on what has been borrowed. You don’t pay interest on the part of the loan that will be paid out later. Some lenders will also permit interest only payments until the house is completed. Interest rates for the construction loan will be a little higher and down payment requirement may be different from the final mortgage loan.

Many lenders will require two complete loan applications and closings; one for the construction loan and then another full process for the mortgage loan. Several of the larger mortgage lenders are now offering a “single close construction to permanent” loan product. This loan has one application and one closing. When occupancy is approved the lender will simply convert the total amount of your construction loan to a permanent mortgage. The single closing also safes money on appraisals and deed recording fees.

If you qualify for a VA loan, the VA does not back construction loans. So what many veterans do is get a single close loan to build the house and then once the house is completed just refinance it with the VA for lower interest rates and waiver of mortgage insurance under the VA program.

If your new home will require a loan, it’s a good idea to start your new home process with exploring various loan products and getting a pre-approval so you can design that new home to fit into your budget.

Please reach out to Morgan Davonn so we can provide you with some lender names and answer any additional questions you might have.

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