Financing Your Dream Build: The Construction Loan
Building a home from the ground up is an exciting prospect, but its financing differs significantly from buying an existing house. A construction loan is a short-term, higher-interest loan that covers the cost of building your home. Our Construction Loan Calculator is designed to help you understand the unique payment structure of these loans, which typically involves an initial interest-only period followed by conversion to a standard mortgage.
How Construction Loans Work
Construction loans are not paid out as a lump sum. Instead, the lender releases funds in stages, or "draws," as construction milestones are completed. A key feature is the interest-only period:
- During the construction phase (typically 9-18 months), you only pay interest on the money that has been drawn to date. This keeps payments lower while the house is being built.
- Once construction is complete, the loan is either converted into a permanent mortgage or paid off with a separate mortgage. At this point, you begin making regular payments of both principal and interest.
Planning Your Budget with the Calculator
This tool helps you estimate two key numbers for your budget:
- Interest-Only Payment: This is your estimated monthly payment during the building phase, calculated on the full loan amount. In reality, your payments will start smaller and increase as more funds are drawn.
- Principal & Interest (P&I) Payment: This is your estimated monthly mortgage payment after the construction is finished and the loan converts to a standard amortizing loan.
Understanding both payments is essential for managing your cash flow during and after construction. For more detailed mortgage calculations, you can use our Mortgage Calculator.
Types of Construction Loans
There are generally two main types of construction loans to consider:
- Construction-to-Permanent Loan: This is a single-close loan that covers the construction costs and then automatically converts to a permanent mortgage once the home is built. This is often more convenient and can save on closing costs.
- Standalone Construction Loan: This is a two-close option. You first take out a loan for the construction period. Once the home is built, you pay off that loan by taking out a separate, new mortgage. This can offer more flexibility but may involve more paperwork and two sets of closing costs.
For additional reading, the Consumer Financial Protection Bureau provides a helpful overview of construction loans.