If you want to build a new home and you don't have enough cash to pay for all of the expenses upfront, you must obtain a construction loan. If you haven't repaid the construction loan by the time your home is complete, you must convert the construction loan into a traditional mortgage.
About Construction Loans
Although standard mortgages typically have terms of 15 or 30 years, construction loans provide only temporary financing. While the builders are working on your home, you will make only interest payments on the loan, as opposed to payments of interest and principal. However, the balance of the loan becomes due in full when the home is complete. At this point, either you must pay the balance in cash, or you must obtain alternate financing.
Obtaining a Mortgage
If you have a standard construction loan, you can convert it to a standard residential mortgage by applying with the same or another lender before your home is complete. The lender will clear the loan to close after you have a certificate of occupancy, and you can use the funds the lender releases to pay the balance of your construction loan. After you have paid this balance, your construction loan will no longer exist, and you can begin making monthly mortgage payments of principal and interest.
Construction to Permanent
Some lenders offer specialized construction-to-permanent financing programs for borrowers who want to build a new home. With a construction-to-permanent loan, the same lender handles both your construction loan and eventual mortgage. Like a regular construction loan, you will make only interest payments during construction. However, instead of asking you to pay the balance of the construction loan after your home is complete, the lender will automatically convert the loan to a standard mortgage, and you will begin paying both principal and interest each month.
Lenders sometimes require borrowers to obtain a preapproval for a standard mortgage before they will close on a construction loan. Most construction loans come with variable interest rates. However, after the home is complete, you can obtain either a fixed rate or variable rate mortgage. Construction-to-permanent loans may carry either fixed or variable interest rates during the construction period but convert to a fixed rate mortgage after construction has ended.
Amanda McMullen is a freelancer who has been writing professionally since 2010. She holds a bachelor's degree in mathematics and statistics and a second bachelor's degree in integrated mathematics education.