Navigating home construction loans


You have decided to create the space you always wanted and want to build your dream home – or complete a major renovation. The next step is maneuvering the construction loan process.

While a mortgage involves the lender and the borrower, the construction loan includes a third party – the builder.

Like all home loans, interest rates depend on multiple factors. Lenders qualify you based on credit score, debt-to-income ratio and the percentage to be financed. Generally, interest rates for a construction loan are higher than mortgage rates.

Additionally, many loans require the lender to make payments directly to the contractor. These payments are made in installments as construction deadlines are met. After construction is complete, the loans are either converted to permanent mortgages or paid in full.

A variety of home construction loans are available. Below is a brief overview of the most common ones.

Home remodel loans

The amount you can finance to renovate your existing home depends on the appraisal value of the property after the improvements are made. Your contractor and the renovation plans need to be approved by your lender. The funds are submitted directly to the contractor.

In general, a construction loan offers a longer repayment period and a lower interest rate than a home equity line of credit or a personal loan.

Renovation construction loans

Also known as a 203(k) loan, the renovation construction loan adds in the cost of major renovations to the mortgage instead of being financed after closing. The loan is based on the home’s value after repairs and renovations. These loans make sense if you are buying a fixer-upper but do not have the cash required for renovations.

New construction loan

When you are building a home from the ground up, there are no improvements to secure the loan, so expect the lender to thoroughly review your finances, the architectural plans and your builder. The lender will pay home construction loans to the builder in installments, which is called a draw. Each draw coincides with a key phase of the project, such as pouring the foundation, framing and finishing work.

An inspection is typically required before each draw is released to the builder, and the amount of that payment is based on the work completed, as noted in the inspection report.

Construction-to-permanent loans

This one-time loan funds the construction, then the borrowed amount is converted to a permanent mortgage after the building is complete. Also known as a single-close construction loan, the interest rate is locked in at closing. Borrowers make interest-only payments while the home is under construction. Because the interest rate for these loans can be high, shop around.

Construction-only loans

A construction-only loan, or two-close construction loan, is a short-term loan that must be paid off when construction is completed. The interest rate is higher than a traditional loan, and there will be a second set of loan fees when you apply for a traditional mortgage. Construction-only loans are an option if you have large cash reserves or want to shop for a permanent lender while building.

Owner-Builder Loans

The owner-builder loan is for borrowers who want to act their own contractor. However, the borrower must demonstrate through experience and licensing that they have the expertise to supervise and manage the construction.

Murfey Company is a leader in residential and nonresidential development in San Diego and Southern California that is committed to excellence and helping clients navigate the building process. Murfey Company also has extensive expertise in negotiating and securing construction loans and can be a tremendous resource in getting projects financed. For more information, visit