A short term interim loan for financing the cost of construction. The lender advances funds to the builder as the work progresses.
A construction loan differs from a typical mortgage. For one thing, it is used for a home that you are having built instead of for a resale home.
With a construction loan, the lender needs to know exactly what is going on with the building of the home. The lender may want to know the timeline of completion of the home as well as the details of the actual construction. That is because in these circumstances, you get a construction loan and the builder draws money from it as needed during the process of building the house. The lender needs to make sure that the money is going where it is intended.
With a construction loan, you make interest-only payments during the actual construction period. When the home is completed and you receive the certificate of occupancy, then the entire balance of the loan is due. That means you will probably need a new mortgage. Construction loans also have adjustable interest rates and are for short terms.
Not all new construction requires a construction loan. For example, if you are building in a new construction community, chances are you will be able to get a conventional mortgage. Construction loans are typically used for custom homes.
If you do have a construction loan, the loan must be paid off when the home is completed. When you get the construction loan, talk to your lender about how to convert it to a traditional mortgage so that when the time comes, you are prepared to do that. If your loan is a construction-to-permanent loan, then you do not have to sit through another closing although you do not have flexibility upon completion of your home to change your interest rate or terms. Of course, with most construction loans, you can always find another lender with which to get a first mortgage and pay off the construction loan that way.