A construction loan is a loan that covers the cost of building or renovating a home. it’s a short-term loan, usually for less than one year. Home construction loans can be used to purchase land and build a home, or construct a home on land you already own. New home construction loans work differently from regular mortgage loans. The loan is designed to pay the contractors and subcontractors in regular installments based on how much of the work has been completed at each stage of construction. Construction loan pays a series of advances, more commonly called “draws,” as the home is being built. Throuhgout the construction, interest-only payments are made on the balance of the money you’ve drawn. The lender disburses smaller lump sums, to your general contractor to pay all of the parties working to complete your home. The typical construction mortgage is designed with a five- to seven-draw schedule, although there can be many more for complex projects.
Once the newly-built home is complete, the loan is paid off or converted into a “permanent” loan, which works like a traditional mortgage with principal and interest payments.