What are the Different Types of Construction Loans?

Allison Boelcke

A construction loan is personal financing for building or renovating a house. A borrower can apply for financial assistance for completing a household project or request a significant amount of money to build a home on an empty piece of property. These loans are typically intended to be short-term loans that occur only during the construction phase. There are different types of construction loans available, but they can widely vary depending on the construction project.

A construction project.
A construction project.

One of the most common types of construction loans are one-time close loans. A one-time close loan is when a financial institution lends a borrower a set amount of money to be paid off during the period of the home construction. For instance, if the estimated completion time for a home to be built is one year, the borrower will generally make 12 monthly payments to get the loan paid by the time the project is finished.

A man working on a construction project.
A man working on a construction project.

One-time close loans are short-term loans that have a set interest rate. If construction takes longer than the loan agreement states, the borrower may have to pay penalties. Once the home is built, the lender can convert the loan into a long-term mortgage to finance the actual house payment. The construction loan is generally regarded as one paid year of the mortgage.

Another type of construction loan is a note modification loan. This loan is similar to a one-time close loan in that it can be converted to a mortgage after the project is finished. A note modification loan generally has a payment rate that starts out small and increases in price as construction is done. After the project is completed, the borrower can choose a new mortgage payment rate that is locked or variable. A locked payment rate stays the same even if the value of the house declines, while a variable rate is adjustable to current market value.

A two-time close construction loan begins with a payment schedule that pays off construction costs by the time the house is completed. Once the construction is done, a borrower can refinance a new mortgage payment plan rather than continuing with the same rates. Two-time close construction loans tend to be used for more expensive building projects because the construction payment rates may be higher than the long-term mortgage payments need to be.

Some financial institutions offer construction loans based on the specific project type. A borrower can apply for a short-term manufactured home loan. This type of loan can cover the costs of delivery for the house parts from a factory and the cost of having it put together on a specific site. There are other specialized construction loans for log home and mobile home construction as well.

Materials for construction.
Materials for construction.

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