A construction loan (also known as a “self-build loan”) is a short-term loan used to finance the building of a home or another real estate project. The builder or home buyer takes out a construction loan to cover the costs of the project before obtaining long-term funding. Because they are considered relatively risky, construction loans usually have higher interest rates than traditional mortgage loans.
Construction loans are usually taken out by builders or a homebuyer custom-building their own home. They are short-term loans, usually for a period of only one year. After construction of the house is complete, the borrower can either refinance the construction loan into a permanent mortgage or obtain a new loan to pay off the construction loan (sometimes called the “end loan”). The borrower might only be required to make interest payments on a construction loan while the project is still underway. Some construction loans may require the balance to be paid off entirely by the time the project is complete.
All you need to know
Such loans come with unique characteristics, such as the length of the loan term and the manner in which loan funds are disbursed to the borrower.
There are features and characteristics of construction loans that distinguish them from other types of loans, such as home mortgage loans or business equipment financing loans. The following example presents the most common type of construction loan – one granted to a builder or property developer to fund residential property development.
Personal construction loans, which are granted to individuals looking to build their own home, may be one of two types. A construction-only type of loan provides the projected necessary amount of money to construct a home. An individual who takes out such loans is expected to pay off the loan in full at the end of construction, although they may do so by then taking out a separate mortgage loan on the newly built home.