Construction Loans vs. Mortgage Loans - What's the Difference?

Construction Loans vs. Mortgage Loans

When it comes to building a house, most people assume that you need to have deep pockets to obtain a construction loan. They're not wrong to assume that, as most builders do require cash installments, or a form of construction financing from a lender. Construction loans are available to anyone who meets the qualifying eligibility requirements.

So what is a construction loan, and how are they different from typical mortgage loans?

 A construction loan is used to finance the construction of homes, vacation homes, commercial buildings, offices, etc. Construction loans are different from traditional mortgage loans in a variety of ways:

1. Funds Due

The main difference is that with a Traditional Mortgage, the financed portion of the funds are provided all at once at the time of closing. On the other hand, a Construction Loan pays out a certain amount throughout specific stages of the build.  

2. Down Payment Amounts

Construction Loans typically require a larger down payment than traditional mortgage loans, and the interest rates tend to be higher as well. In addition, during the building process, the borrower is required to make interest only payments.

3. Length of Financing

Constructions loans place time frames on the building process, typically requiring that the project be complete within 12 months. Once the build is complete, the construction loan can be paid off in a variety of ways, depending on the term of the original loan. In some cases, construction loans are paid off with "end loans" which is another term for a mortgage. Or, the construction loan can also be paid off in full by the borrower once the build is complete.

This differs from regular mortgages because traditional loans vary in length (typically between 5-30 years) and are determined by the original loan terms. You also start paying monthly mortgage payments a month or two after closing. 

 

Why are those obtaining traditional mortgages usually unable to build a house?

This is because mortgages requires some sort of asset or collateral to back the loan. To explain further - a mortgage is used to finance the purchase of an existing home. This existing home is used as collateral should the borrower default on their loan. However, when building a home, there is no collateral since there is no existing home to secure the loan. This is why people believe they either need loads of cash, or, the ability to obtain a construction loan, if they want to buy a home.

Does this mean I can't build a home without having deep pockets or getting a construction loan?

NO! It is actually common to stumble across a few builders who do not require a specific type of financing to build from the ground up. That means building a house is possible when you're obtaining a typical mortgage financing such as USDA, FHA, VA, Conventional, etc. 

Contact us today to learn how we can help build your perfect home!