Construction Loans

Whether you’re a homeowner looking to build from the ground up or a real estate investor tackling a large project, understanding how home construction loans work can help you secure the right financing. In this guide, we’ll break down the types of construction loans, how they work, and what you need to qualify.

What Is a Construction Loan?

A construction loan is a type of residential transition loan (RTL) that serves as a temporary financing option that funds the costs of building or renovating a property. Unlike traditional mortgages that provide a lump sum upfront, these loans disburse funds in stages as construction progresses, ensuring better cost management.

Private money loans are a common choice for construction financing, especially for borrowers who may not meet the strict requirements of conventional lenders or need more flexible terms. Homebuilders, real estate investors, and individuals looking to construct a custom home often use these loans. Understanding how construction loans work, including their types and requirements, can help you find the best financing solution for your project.

How Do Construction Loans Work?

Construction loans work differently from traditional home loans because they are designed to fund a project in phases rather than providing a lump sum upfront. Instead of receiving the full loan amount at once, borrowers get funds in installments—called “draws”—as construction progresses. Lenders typically require inspections at each stage to ensure the work is completed before releasing the next portion of funds.

During construction, most loans require interest-only payments based on the amount disbursed rather than the full loan amount. Once construction is complete, the loan must either be paid off in full, refinanced into a traditional mortgage, or converted into a permanent loan, depending on the loan type. Because of this structure, new home construction loans provide the flexibility to finance new builds or major renovations while ensuring funds are used appropriately throughout the project.

Types of Construction Loans

There are several types of construction loans, each designed to meet different financing needs. Whether you’re building a home from the ground up, renovating an existing property, or purchasing land for future construction, understanding these loan options can help you choose the best fit for your project.

Construction-to-Permanent Loan

A construction-to-permanent loan simplifies financing by combining the construction loan and long-term mortgage into one. During the construction phase, borrowers typically make interest-only payments based on the amount disbursed. Once construction is complete, the loan automatically converts into a standard mortgage, with principal and interest payments beginning.

This option is ideal for borrowers who want to avoid the hassle of applying for separate loans, as it eliminates the need for refinancing and additional closing costs. It’s an excellent choice for those who plan to live in the home long-term and want an easy transition from construction to permanent financing.

Construction-Only Loan

A construction-only loan covers the cost of building but must be paid off or refinanced once construction is finished. Unlike a construction-to-permanent loan, this type of financing does not automatically convert into a mortgage, meaning borrowers will need to secure permanent financing separately.

While this option provides more flexibility in choosing a long-term loan, it can also be more expensive due to the need for multiple loan applications, closing costs, and potential interest rate changes. Some borrowers, particularly real estate investors or those working on short-term projects, may opt for a hard money loan as a construction-only financing option. Hard money loans are funded by private lenders and offer quicker approval and more flexible terms, though they often come with higher interest rates.

Renovation Loan

A renovation loan is designed for homeowners who want to remodel or improve an existing property. Unlike traditional home loans, which are based on the home’s current value, renovation loans provide funds based on the post-renovation value, allowing borrowers to finance extensive upgrades, structural changes, or major repairs.

These loans are a great option for those looking to modernize an older home, increase property value, or customize a house. Common renovation loan programs include FHA 203(k) loans, Fannie Mae’s HomeStyle loan, and other specialized financing options catering to different borrowers’ needs.

Lot Loan

A lot loan helps borrowers finance the purchase of land for future construction. These loans are ideal for securing a plot before finalizing construction plans or obtaining building permits. However, lot loans typically require a larger down payment, higher interest rates, and stricter lending requirements since undeveloped land carries more risk for lenders.

Some borrowers use lot loans as a temporary solution before transitioning into a construction loan when they are ready to build. This option is best for buyers with a long-term vision for their property but who need financial flexibility before breaking ground.

Construction Loan Rates

Construction loan interest rates are usually higher than traditional mortgage rates because of the increased risk lenders take on during the construction process. Unlike a standard home loan, which is secured by an existing property, a construction loan is based on a project that has yet to be completed. This uncertainty makes lenders more cautious, leading to higher interest rates to offset the risk.

Several factors impact construction loan rates, including the borrower’s credit score, loan amount, down payment, and the project’s overall risk. Lenders also consider the construction site’s location, the builder’s experience, and market conditions when determining interest rates.

Additionally, construction loans are short-term, so they often have variable interest rates that fluctuate based on market conditions. Once construction is complete, borrowers can typically refinance into a traditional fixed-rate mortgage, which may offer lower and more predictable payments.

Apply for a Construction Loan Today

If you’re ready to build your dream home or take on a major renovation, Griffin Funding can help you secure the right construction loan for your needs. With competitive rates, flexible financing options, and a streamlined application process, we make it easy to fund your project from start to finish. Whether you’re looking for a construction-to-permanent loan or a non-QM mortgage, our team is here to guide you every step of the way.

Keeping track of your loan has never been simpler with the Griffin Gold app – track your loan status, submit documents, and stay connected, all from the convenience of your mobile device. Turn your vision into reality with Griffin Funding. Get started today!