Construction Loan
Definition and meaning of Construction Loan in real estate.
A construction loan is a short-term, high-interest real estate loan used to finance the building of a home or another physical structure. The lender disburses the funds in stages called draws as the construction work is completed rather than as a single lump sum.
In more detail
These loans typically last for only the duration of the building process, which is often one year or less. During this period, the borrower usually makes interest-only payments based on the amount of money drawn so far. Because the home does not yet exist to serve as collateral, these loans carry higher risk for lenders and require detailed project plans and a qualified builder.
Once construction is finished, the borrower must either pay off the balance in full or transition the debt into a traditional long-term mortgage.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Typical term | 12 months or less |
| Repayment type | Typically interest-only during construction |
| Funding method | Disbursed in stages based on project milestones |
A homebuyer secures a construction loan to build a custom house, and the lender pays the contractor in installments after inspectors verify that the foundation, framing, and plumbing milestones are met.
Frequently asked questions
How does a builder receive money from a construction loan?
The lender releases funds to the builder in increments called draws. This happens after the builder submits receipts and a third-party inspector verifies that each specific phase of construction has been completed satisfactorily.
Are interest rates higher on construction loans than regular mortgages?
Yes, interest rates are typically higher on construction loans. This is because the loan is short-term and the property is not yet finished, which represents a higher risk for the lender.