How do construction loans work?

Construction loans are short-term (6-12 months) loans that fund home building. Unlike traditional mortgages, you draw money as needed during construction phases. You pay interest only on drawn amounts during construction. After completion, the loan converts to a traditional mortgage or you refinance with a new loan. Rates are typically 1-2% higher than standard mortgages.

What's the difference between construction-to-permanent and stand-alone construction loans?

Construction-to-permanent loans automatically convert to a mortgage after building completes—one application, one closing. Stand-alone loans require separate refinancing after completion—two applications, two closings, more fees. Construction-to-permanent loans save money and hassle but lock you into current rates. Consider rate trends when choosing.

How much down payment do I need for a construction loan?

Construction loans typically require 20-25% down payment, higher than standard mortgages. This could be paid as: cash, land equity (if you own the lot), or combination. Lenders view construction as higher risk. Your down payment might be released gradually during construction rather than all upfront. Plan for significant upfront capital.

What happens if construction goes over budget?

Cost overruns are common (10-20% typical). If construction exceeds loan amount, you must pay the difference out-of-pocket or the builder must absorb costs. Build contingency into your budget (10-15%). Some lenders allow loan increases if you have additional down payment. This is why detailed, conservative budgeting is critical before starting construction.