Reviewed by Sep 30, 2020| Updated on
A construction loan, also known as a self-build loan, is a short-term loan used to finance the construction of a home or other real estate project. Once long-term financing is secured, the contractor or home buyer must take out a construction loan to cover the building costs. A construction loan typically has a higher interest rate than a conventional mortgage loan, since it's considered riskier.
Construction loans are typically taken out by contractors or a homebuyer who custom-build their own home. They are short term loans, usually for one year. The borrower may either refinance the construction loan into a permanent mortgage or receive a new credit to pay off the construction loan, called the "end loan", after the construction of the house is complete.
The borrower would only be asked to pay interest on a construction loan when the project is still underway. Many construction loans can require payment of the balance in full by the time the project is complete.
Many lenders demand a minimum 20% down payment on a construction loan, and some allow up to 25%. Borrowers can face difficulty securing a building loan, particularly if they have a limited credit history.
There could be a lack of collateral as the home is not yet constructed, which poses a challenge in obtaining a lender's approval. The borrower would need to provide the lender with a detailed list of design information (also known as a "Blue Book") to obtain approval for a building loan. The creditor would also have to show that the project includes a professional contractor.
Local credit unions or national banks provide construction loans. Local banks may be familiar with their area's housing market and make home-building loans more convenient for borrowers within their locality.