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How Do Home Construction Loans Work?

Building a new house can be an exciting time. You’re preparing to customize your home to suit your needs exactly — maybe you’ve even been dreaming about this house for a long time. To help prepare you for financing a new build, we’ve outlined some key points of home construction loans, so you can move forward with more confidence.

close up of a hammer and nails on top of blueprints

What Is a Home Construction Loan?

A home construction loan is a short-term loan that covers the cost of building a house. Many construction loans cover the price of the land as well as the cost of the construction. You will need estimates from several construction firms or contractors — ask your lender if they have a list of approved builders. The bank will want to examine the building plans, an estimated schedule from the construction company, and an initial budget. With this information, your lender can help estimate how much you need to borrow.
During the building period, you only pay interest on the loan. After construction is finished, your payments will grow to cover interest as well as the principal.

Two Types of Construction Loans

Depending on your current living circumstances, you can choose one of these two types of construction loans.
Stand-Alone Construction Loans
This loan covers only the expenses incurred during the construction process. You will then need to secure a separate mortgage loan after the house is built. You may already have a mortgage on your current house, which you’re planning to sell once construction is complete. You might choose to wait to apply for a traditional home loan until you sell your house so you can make a greater down payment.
Construction-to-Permanent Loans
This loan packages a home construction loan with a traditional mortgage loan. This way, you won’t have to go through two closings or refinance after construction has finished. The bank will simply convert the home construction loan into a mortgage after the house is built.

I’m Approved. Now What?

After you’ve received your home construction loan approval, your lender and your construction company will arrange a draw schedule. Four to six draws are typical. The scheduled fund dispersals will occur after benchmarks in the construction, such as pouring the foundation, rough framing, roofing, heating, ventilation and cooling (HVAC) installation, etc. The contractor will submit draw requests to the bank, which will have to respond efficiently to ensure subcontractors receive timely payments.

Title Insurance

Lenders will likely require you to procure a Loan Policy of Title Insurance. This policy protects the lender’s investment. It protects the bank if there are any existing liens on the property or if the builder fails to pay the subcontractors. You can choose to obtain an Owner’s Policy of Title Insurance to protect your own interest as the owner against the same types of issues.

Where to Find a Home Construction Loan?

Speak to a bank representative to find out about qualifying for a home construction loan and to inquire about approved contractors. We would be very happy to discuss your upcoming project at any of our Southern Wisconsin or Northern Illinois locations.