Construction loans are typically variable rate loans that are priced at some spread of the prime rate. You would normally seek a construction loan if you were planning to build a house or perform a major renovation on a home in which you have little or no equity. Construction loans provide you with a pool of liquid cash resources that you use as needed to build or renovate your home. You are usually only required to pay the interest on the loan when you draw funds. You are however required to pay the loan in full at the completion of construction. A certificate of occupancy normally signifies this event.

Construction loans are considered story loans. This means that the lender must know exactly why you need the loan and what the intended use of funds are. This explanation of why the money is referred to as ‘the story’. Construction loans are also not underwritten to Fannie Mae guidelines so they are not always standardized although you will find common features among competing lenders.

Keep in mind that the lender may not be willing to lend the entire cost of the project unless you have some equity in the home or land that the construction is taking place on. This equity can be used to secure the construction loan.

It is typical for homeowners to convert their construction loans to standard mortgages at the conclusion of construction. This process is known as construction-to-permanent financing and most lenders will provide this option to you. There are normally higher costs associated with construction loans of this type, but the upside is the peace of mind of a rate lock and the convenience of a single loan form.