DEFINITION of ‘Construction Financing’
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 fairly risky, construction loans usually have higher interest rates than traditional mortgage loans.
Also known as a “self-build loan.”
BREAKING DOWN ‘Construction Loan’
Construction loans are usually taken out by builders or home buyers who are custom-building their own home (see Getting A Mortgage When Building Your Own Home). Once construction on your house is completed, you can either refinance the construction loan into a permanent mortgage or get a new loan to pay off the construction loan (sometimes called the “end loan”).
At a minimum, most lenders require a 20% down payment on a construction loan, and some require as much as 25%. To gain approval for a construction loan, you’ll need to provide the lender with a comprehensive list of construction details (also known as a “blue book”) and prove you have a qualified builder involved in the project.
Rarely found online, construction loans are usually offered by local credit unions or regional banks. Because local banks are familiar with the housing market in their area, they are generally more comfortable making home construction loans to borrowers in their community.
If you intend to act as your own general contractor or build the home with your own hands, you will likely need to take out a variant of this type of loan called an owner-builder construction loan.