How Do Construction Loans Work?

Construction loans are temporary loans to finance the building of a home. Lenders will usually lend you 70% to 100% of the after completed value. The loans can be used to pay for land/lot, materials, and labor costs.

A construction loan will need to be refinanced into a permanent loan after the completion of construction. However, there are now construction-permanent loans that will automatically adjust to a permanent loan after the construction phase is completed. They are also referred to as one time close construction loans, because you don't need to get a different loan later on.

Most banks require that the builders be experienced in constructing like homes. In addition to the normal loan documents, contractors will need to furnish their resumes and references to the lending bank.

Other documents such as permits and contracts between the buyer and the contractor will be necessary. The lender might have particular requirements that the contractor has to follow in order to be paid.

You typically have to have good credit for construction loans and most lenders will require 4-6 months of P&I reserves.