Everything You Need to Know About Construction Loans

If you are a homeowner, you may be wondering if there is a way to finance your home renovation project without paying high interest rates.

The answer is yes! A construction loan can be a great way to finance your project without paying a ton of interest.

Borrowers benefit greatly from construction loans, such as the FHA's 203K or the FNMA (FannieMae) HomeStyle loans, because they can provide a larger loan than other options.

How is that possible? Construction loans are based on the worth of your home following renovations.

A Construction Loan Isn't for Everyone

Construction loans are not without flaws. Sometimes, if the renovation is a small task, a homeowner may decide to go for personal loans instead.

In this article, we will discuss what construction loans are, the benefits, and how you can get one for yourself.

So, if you're ready to start building your dream home, keep reading!

What is a Construction Loan and How Does it Work?

A construction loan is a short-term loan that is used to fund the building or renovation of a residence. They are most commonly utilized by homeowners who are building their own homes rather than buying one that is already built. But in this article, we will focus on renovations. 

Construction loans are considered to be higher risk than traditional mortgages, and as such, they usually have higher interest rates.

Types of Construction Loans

Construction loans are usually divided into two categories: "construction-to-permanent loans and stand-alone construction loans - the former being the most common type."

However, there are a couple of additional alternatives.

  1. Construction-to-Permanent Loan

They are also sometimes called all-in-one loans or single-close loans.

This kind of loan allows you to borrow money to pay for the construction of your home, converting the loan into a traditional mortgage after the construction is completed. This means that you'll only have to complete the loan application process once.

  1. Stand-Alone Loan

Stand-alone construction loans are less common and, as the name suggests, they are separate loans from your mortgage.

With this type of loan, you will have to go through the loan application process twice: once for the construction loan and then again for the mortgage.

  1. Owner-Builder Loan

Instead of being paid to a third-party contractor, the owner-builder is paid. Owners who have experience as a homebuilder or who have a contractor's license are usually eligible for these loans.

This loan is a good option for homeowners with prior construction experience who want to function as their own general contractor.

  1. Renovation Loan

Renovation loans are similar to typical mortgages in that they cover the cost of acquiring a home as well as major modifications. As a result, the loan amount is determined by the home's expected worth following the improvements.

Buyers of fixer-uppers who expect to spend a lot of money on renovations tend to choose this type of construction loan.

How Do You Know If You Need a Construction Loan?

If you're a homeowner and you're thinking about making some improvements to your home, you may be wondering if you need a construction loan. This type of loan can be beneficial if you plan to make significant improvements to your home and increase its value.

However, these can be more expensive and complicated than traditional mortgages, so it's essential to do research before deciding if a construction loan is right for you.

Below, we've compiled a few basic things to consider when deciding if you need a construction loan.


If the cost is less than 20% of the appraised value of your home, then you may be able to finance the project with a traditional mortgage. If the cost exceeds 20%, you'll almost certainly need a construction loan.


Another thing to consider is the timeframe of the project. If you're planning on making improvements that will take less than a year to complete, a construction loan may not be necessary.

However, if the project will take longer than a year, you may want to consider a construction loan so that you can make interest-only payments during the construction period, converting to a traditional mortgage once the project is completed.

Financial Situation

The final thing to consider is your overall financial situation. If you have good credit and enough equity in your home.

You may not be able to qualify for a construction loan if you have bad credit or insufficient equity.

If you're still not sure if you need a construction loan or not, it's always a good idea to speak with a financial advisor to get more information. They can help you understand your options and make the best decision possible.

What Are the Benefits of Getting a Construction Loan?

There are several reasons construction loans are popular among homeowners. They allow you to create your dream home from the ground up, may have lower interest rates than other types of loans, and you only have to pay interest while the house is being built, saving you money.

Construction loans also come with some risks that should be considered before taking out this type of loan.

The most significant risk is that you may end up owing more money than the value of your home if construction takes longer than expected or if costs exceed what was estimated.

Before applying for a construction loan, work with a trustworthy contractor and receive accurate cost estimates. You must be able to ensure that you will be able to make the monthly payment.

What Are the Risks of Getting a Construction Loan?

Like any loan, there are risks associated with taking out a construction loan. These risks include:

  1. You may not qualify for the loan. In order to get a construction loan, you will need to have good credit and a steady income. If you do not have these things, you may not be able to get the loan.
  2. The interest rates on construction loans are usually higher than the interest rates on other types of loans. This means that you will have to pay more in interest over the life of the loan.
  3. You may not be able to get the loan for the full amount that you need. This means that you will have to come up with the rest of the money yourself.
  4. You may not be able to get the loan at all. This is a risk that you take when you apply for any loan.
  5. If you are not able to make the payments on your construction loan, you could lose your home. This is a very real risk that you need to be aware of before you take out a construction loan.

These are just a few of the risks that you need to be aware of before you take out a construction loan. Make sure that you understand all of the risks involved before you sign any papers.

Tips for the Loan Process

If you're considering a construction loan for your next home, here are a few tips to help you through the process:

What Other Types of Loans Are Available to Homeowners?

Other options to consider besides construction loans are traditional home mortgages, home equity loans, or lines of credit.

Examine the benefits and drawbacks of each option before making your decision, and consult your financial advisor to determine the best solution for you.

Construction loans can be a great way to finance your dream home, but make sure you understand the risks involved before taking out this type of loan.

Before signing any paperwork, work with a trustworthy contractor, get numerous bids, and make sure you understand all the terms of each contract.

Homes are a significant investment; maybe the most significant investment many individuals will make in their lives. It's only reasonable that you'd want to safeguard your investment in every possible way.

Construction insurance is one way for homeowners to achieve this.

Construction Insurance

Construction insurance is important because it protects your home from damage during the construction process. It covers things like fire, wind, hail, water damage, and more.

The two types of construction insurance are Builder’s Risk insurance and Course of Construction insurance.

To receive the coverage you need for your project, be sure you grasp the difference between Builder's Risk insurance and Course of Construction insurance.

Talk to your contractor or financial advisor to learn more about construction insurance and how it can protect your home.

How Much Money Can You Borrow With a Construction Loan?

Construction loans are typically short-term loans with a variable interest rate. The loan is meant to cover the cost during the building phase or renovation of a home.

Because construction loans are risky for lenders, they usually require a higher credit score and down payment than other types of loans, such as a personal loan or mortgage.

The amount you can borrow with a construction loan depends on the value of the property you're building or renovating. The interest rate will be higher than other types of loans, but it can be lower than what you'd get with a personal loan or credit card.

Senior Lien

It's important to note that a construction loan becomes a senior lien, which you may not be aware of. The bank that is offering you a renovation loan takes over your mortgage, pays it off, and you now pay them the total amount over time.

How to Choose Your Construction Loan Lender

When it comes to choosing a construction loan provider, there's a lot to think about, and it's easy to get overwhelmed. As a result, it's tempting to go with the first lender you see. However, you should not make this decision hastily.

Ask these questions to make sure you choose a lender that is right for you:

But What About That Fantastic Mortgage Interest Rate You Got?

Rates are normally roughly 1% more than standard mortgage rates, meaning that today, construction credit rates range between 5% and 6%; thus, construction loans are riskier than typical mortgages since they are not secured by a completed house.

According to A 203K loan will cost you 1% more than a conventional loan. So your initial mortgage ($427,500) and your renovation loan ($100,000) now have a 4.5% interest rate.

To give you an idea of the difference, your original 3.6% interest rate on your $427,500 mortgage amounted to $271,929.21 in interest.

With a 4.5% interest rate, the total comes to $352,288.68. (before the renovation loan). That's an additional $80,359.47.

And don't forget that interest rates have recently risen (and are continuing to rise), so your new construction loan rates may be considerably higher.

But wait, there's more: closing expenses typically range from 2% to 5% of the total amount. 

So your original loan ($427,500) had $17,100 in closing expenses (4%).

Your additional $100,000 loan should only cost $4,000 in closing charges, but because this loan is senior and replaces your old mortgage, your closing costs will be around $21,100. That's a difference of $21,100.

How Long Does the Approval Process Usually Take?

The construction loan approval process can take anywhere from 30-90 days. A homeowner’s credit score is taken into consideration, similar to a regular mortgage. The home value itself is the secondary criteria to ensure that it can be secured and you get a lower rate.  

This type of loan also requires that you have a contractor lined up and ready to begin construction as soon as possible after your loan closes.

Construction loans are definitely worth investigating if you're planning on building your dream home. They offer many benefits that other types of loans don't, and with today's low-interest rates, now is a great time to get started.

Work with an experienced lender and make sure you have all of your ducks in a row before beginning the procedure. It'll make things go more smoothly and help you end up with the home of your dreams.

What to Do Next?

If construction loans are something you're considering as a homeowner, your next step is to sit down and talk with a loan specialist.

They will be able to help you determine if a construction loan is the right fit for your home improvement project. Remember, construction loans are not for everyone - but they can be a great option for those who qualify.

Make sure to ask your loan professional any questions you have regarding construction loans or the construction loan process.

Consider Taking a Different Route

What if you don’t have enough equity in your house or are simply looking for another way to get much-needed renovations done? 

At Housetable, we offer something else entirely. We offer home equity loans specifically designed for home renovations where, instead of borrowing against the current value of your home, you can borrow against the projected post-renovation value of your home. 

We do this by using sophisticated technology based on artificial intelligence, which not only allows us to see what the projected post-renovation value (ARV) of your home can be, but also which specific renovation types will add that projected value. 

Using this technology, plus our contractor monitoring program, ensures your lender that your home will become a lot more valuable by using our loan program. We make things easier and take out the stress and guesswork of securing a loan for your home renovation. Plus, you don’t have to refinance and lose your low rates when you go with a Housetable loan.

Schedule your free consultation with one of our expert team members today and learn more about how a Housetable loan can work for you. 


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