What is a construction loan?

1. What is a construction loan?

A construction loan is a short-term loan to finance the building of a new home or remodeling of an existing home. Similarly, a renovation loan is to finance the remodeling of an existing home. We'll refer to both construction and renovation loans as "construction loans" in this article. The funds are paid directly from a bank, like BankSouth, to the builder or contractor in advances for each phase of the building project, known as the "draw schedule". At BankSouth, we have an inspector who verifies the completion of each phase of construction before a draw from your construction loan is made to pay your builder or select subcontractors.

2. What is the difference between a construction loan and a mortgage?

Once you own your lot, a construction loan is the first type of loan you might acquire when building a house. It is set up with multiple withdrawals, and you only pay interest each month on the amount of the loan already dispensed to you.

Mortgages are set up as installment loans for a fixed period and can only be made once your home construction is complete. Because construction loans require a higher level of management than a mortgage, they usually have higher interest rates and down payments.

3. How much money do I need to put down?

Most banks generally require borrowers to invest 20% equity into their new home.

This can be calculated by adding up your total home cost, including the land. Total project cost is best calculated by adding your lot value/price + cost to build. For example, if you paid $100,000 for your land, and your construction budget is $300,000, your total project cost is $400,000, so you would need to invest $80,000 total into your project. This can be paid upfront in the lot if you paid cash, or it can be done in two steps, 20% down on the land ($20,000) and you would bring another $60,000 when you start construction.

4. Do I have to sell my current home before I build in order to access the equity in my house?

Not necessarily! You can pull out equity from your current home on either your lot loan or your construction loan, so you only have to move once! This is sometimes referred to as a "bridge loan".

QUESTION: Tell us about your upcoming custom home build.

5. Which should I consider first: my Construction Loan or Builder/Contractor?

This can depend on where you are in the process. Some people want financing pre-approval so they know how much they can afford when building their home. Others have a contractor and detailed building plans before they start the process to obtain a construction loan. It is important to check with your financial institution because some banks require building plans before they will approve a construction loan.

6. How does a construction loan fit with a lot loan?

If you don’t have a lot yet, you would first obtain a lot loan to purchase your property (or pay in cash). Once you have a lot and your construction is complete, both your lot loan and construction loan will ultimately get rolled over together into a permanent mortgage (this process is sometimes referred to as construction-to-permanent).

To summarize the process:

Lot loan → Construction loan → Extended Rate Lock → Permanent mortgage

Extended Rate Lock is available when you obtain a Construction-Perm loan with BankSouth. This is a 12-month rate guarantee on your mortgage interest rate, so you don’t have to worry about rates rising during the life of your construction loan.

7. What is repaid during the construction period?

You are only required to make interest-only payments during the life of the construction loan, and interest is only due on the amount of the construction loan withdrawals. Principal plus the interest on your mortgage gets repaid during the life of the mortgage, which is typically 15 or 30 years. The principal is the amount of money you borrow from the bank, and interest is the fee you pay for having the loan.

8. How long does a construction loan last?

Construction loans typically last for 12 months but can be extended for a longer term if necessary. Even if the physical construction lasts less than 12 months, your construction loan still lasts the full period. This is beneficial for many people selling their previous home as it gives them time to sell before making full mortgage payments on their new residence.

9. How do I manage my building process?

Once you have your construction loan and building plans, it’s time to get started building your dream house! You may be wondering how you will manage your building process. The management process varies across financial institutions, but we have skilled employees and cutting-edge technology to keep you organized and informed.

Optional Pre-Title

Praeterea iter est quasdam res quas ex communi.

Your financial future is about more than banking. That’s why we help you find the dedicated realtors for your home and your best insurance rates for, well, everything. Your economic well-being matters to us. We want to make sure you’re taken care of everywhere.

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Optional Pre-Title

Praeterea iter est quasdam res quas ex communi.

Your financial future is about more than banking. That’s why we help you find the dedicated realtors for your home and your best insurance rates for, well, everything. Your economic well-being matters to us. We want to make sure you’re taken care of everywhere.

Example Text Link >