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Home›University Fund›Construction loans: funds for building and buying land

Construction loans: funds for building and buying land

By Lisa Perez
March 6, 2020
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Mortgages are easy to find, but there is usually a catch: you can only borrow money to buy a place that already exists. But construction loans are different, and they will fund a new house, garage, or business structure.

They can even help you rebuild and buy land (if you don’t already have one).

Construction loans are less popular than standard home loans but are available from a number of lenders.

If you are considering construction, this site describes the basics of these loans. However, each lender handles things differently, so the details will depend on who you work with.

The basics of a construction loan

A construction loan is a short-term real estate loan. You can use credit to buy land, you can build on properties you already own, and with some programs, you can even renovate existing structures.

These loans are similar to a line of credit: you only borrow what you need when you need it, and you only pay interest on the amount you have borrowed (as opposed to a standard loan, in which you take 100% of the money available to start paying interest on the entire amount immediately).

During the construction phase, you will generally only pay interest (or not pay at all) based on the amount you have borrowed so far. Ascertain milestones are reached, you or your builder will ask for payments for the work completed.

The inspector will check that the work has been done (but will not evaluate the quality of work) and the payment will go to the builder if all is well.

Loans typically take less than a year and are repaid with a new “permanent” loan – you’ll be relieved of a construction loan once construction is complete.

Because construction loans have higher (often variable) rates than traditional home loans, you don’t want to keep the loan forever. To withdraw a loan, you will receive an estimate and an overview of the completed assets and refinance to a more suitable loan.

There are two ways to get rid of a temporary loan:

  • Apply for a new loan after the building is completed, or
  • Schedule both credits in advance (also known as a one-time close)

Construction loan funds can be used for any part of your project: buy land, dig a hole, pour a foundation, frame and finish. You can also build garages, basic sheds, and other facilities, depending on the lender’s policy.

As with most loans, don’t count on lending 100% of what you need. Most lenders require you to put some kind of capital into the deal. Of course, you can bring money to the table, but if you already own the land, you can use the property as collateral instead of cash.

A solid plan

To get a construction loan, you will need to qualify, just like with any other loan. This means that you need good credit and favorable indicators (debt on income and credit for value). Consistent revenue also helps.

Construction loans are unique because the bank has to approve your construction plans

If you buy from a builder who works with a specific lender on a regular basis, approval can be enhanced. However, more “custom” projects can be challenging.

Expect your lender to request complete project information: who is working, how exactly it will be done (architectural drawings will help), what is the schedule, what are the projected costs, whether the structure will meet local codes and requirements, and how much the property will be worth at the end? Unfortunately, you can’t just wing it.

What if you wanted to do all the construction work yourself?

It makes things even more difficult. Banks are hesitant to work with property builders – they fear there is a better chance the project will start off course. Unless you are a full-time professional contractor with years of experience, you will probably need to hire someone else.

Having a plan is great and flexibility is even better. Construction projects are known for delays and surprises, so be sure to leave some room to hang.

Don’t plan on spending everything your bank wants to give you, and don’t plan on moving out of your existing home the day after the project is completed.

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