What are Home Construction Loans?

Home construction loans are those loans that are issued to people who desire to build their own homes, rather than to purchase one that is already built, or one that is being built by a developer. These loans are short-term loans, usually paid back in full when the construction is complete. During construction, interest-only payments are made. Home construction loans are usually paid off by taking a mortgage loan on the home, which will likely be of a smaller amount than if the homeowner had purchased a comparable home that was already built.

The requirements that govern the issuance of home construction loans are not standardized in the way that is typical of a mortgage loan. They are sometimes called story loans, because lenders often want to be familiar with the background story behind the planned construction before the loan is given. The lender will also likely want to know if the land is already owned by the loan applicant, because this could be considered equity for the purposes of the loan.

Because home construction loans are not meant to be long-term like mortgages, their interest rates are not a subject of as much importance as they would be when applying for a mortgage. It is often worth it to accept a slightly higher interest rate on the more short-term loan, especially if the homeowner plans to structure the loan so that a mortgage immediately replaces the construction loan when the home is completed. This is because taking a higher interest rate in the short term could be exchanged for getting a lower one on the long-term mortgage.

Those who choose to build homes with home construction loans usually act as the project manager, or general contractor, for the construction. The owner can also physically contribute during the building process, but he does not have to perform any of the work himself if he doesn't want to. Doing so may save money and time, for those who are able, however. Most people who use home construction loans do so because of the savings compared with buying a new home from a builder. These savings can often be in the range of 15 to 25% or more, making it well worth the trouble.

As is the case with all loans, not everyone who applies for a home construction loan will receive one. The applicant must be seen by the lender as motivated and able to pay the loan back. Creditworthiness is closely scrutinized, as are various other factors. If approved for this type of loan, the home builder will likely find this path to homeownership to be highly rewarding, financially and otherwise.