3 Types of Construction Loans

reviewing construction loan options

3 Types of Construction Loans

Types of Construction Loans

Generally speaking, there are three types of home construction loans that are commonly used in custom home building.  These construction loans are different than a typical mortgage, because they help to pay for materials, the lot, and are structured specifically for the time of construction.

1. Lot Loan

A Lot loan is different than a construction loan because it only pays for the land that the construction will take place on. It is also generally a short-term loan, with the assumption that a home will be built on the property in the near future. Some lenders will transfer a Lot loan into a construction loan. The terms of a Lot loan vary by lender with some offering interest-only loans or interest and principal.

2. Construction Perm Loan

This type of loan is the more common or preferred method for many homeowners. In this scenario, you borrow money to pay for the Lot (if not already owned) and the construction – and there is only one loan closing. One loan closing provides benefits because it often reduces the fees associated with two separate loans. In addition, you are typically able to lock in the long-term rate (or a rate range) for the permanent loan.

During the construction, you pay interest only on the outstanding balance. Typically, the rate is variable during construction and will go up or down based on the prime rate. The lender escrows the funds and releases them after various phases of construction are complete. After construction is complete and a Certificate of Occupancy is obtained, this type of loan is often converted into a permanent mortgage. Some lenders will lock-in a mortgage rate or a range when construction begins. Most lenders require a 20% down payment based on the completed value of the home, but each lender has a variety of loan programs and down payment options, based on what is currently available in the lending market.

3. Stand-Alone Construction Loan

This type of loan establishes a loan for the Lot (if not already owned) and construction costs. When you are ready to move in, you will receive another loan to pay off any remaining construction debt and to provide a permanent mortgage for your new home. This type of loan may be desirable for those that have an existing home, perhaps with equity, that they want to use as credit towards their down payment. However, this type of loan typically requires two closings, which means two sets of fees – first on the construction loan, and then on the permanent mortgage. Rarely are you able to lock in a rate, so you are subject to whatever the rates are, once the house is completed. In addition, you will need to re-qualify for the second loan so it’s important to understand your options and keep credit and spending in check, during the construction of your home. This can prove challenging to some, so a good lender is the key!

One thing to remember is that with both the Construction/Perm loan and the Stand-Alone Construction loan, the loan amount is determined before construction begins. While allowances may be provided in your construction contract, any variance or additional costs would need to be paid out of pocket. Your experienced construction lender will be able to answer specific questions about down payment options, draw schedule, rates, fees, and more.

If you are thinking about building your once-in-a-lifetime custom luxury home, be sure to download our FREE ebook: “Designing & Building Your Custom Dream Home: How to Create an Experience You’ll Love to Remember.”  Ready to get started? Contact Mueller Homes today, and let’s talk!

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