fbpx

The Annual Meeting of The Membership will be held on Tuesday, April 23, 2024, at 5:00 p.m. CST.

October 16, 2022 Mortgage

Difference Between a Construction Loan and a Conventional Mortgage

Buying a home is a significant step in life, but it can be hard to find the right fit. Maybe building a home is more appealing for the needs of your family. But what is the difference between a conventional mortgage and a construction loan?

Construction loans give borrowers access to the funds they need to build a new home.

Traditional mortgages allow buyers to borrow the funds they need to purchase a new home.

Term Length

Traditional mortgages are long-term loans that borrowers payback for years after the loan’s origination. A typical mortgage has a 30-year term during which the borrower must repay the principal loan amount and the interest charges to the lender.

Mortgage terms can vary from 15-year to 40-year terms; not all lenders offer the same rates. Be sure to visit your financial advisor to determine the best option for you.

New construction loans are short-term loans with one year or less payback term. A shorter loan length means the borrower is not making payments on the loan for years or decades to come.

However, since the borrower must repay the entire loan within the year, monthly payment amounts can be significantly higher than traditional mortgage payments.

Interest Rates

Interest rates on conventional mortgages and construction loans fluctuate along with the Prime Rate. However, traditional mortgage interest rates tend to be lower than construction loan interest rates.

The higher rates on construction loans protect the lender from taking a more significant risk with the construction loan than with a traditional home mortgage.

Approval Process

To get pre-approved for a conventional mortgage, you’ll need a decent credit score, a strong credit history, proof of income, a downpayment, and more. Most lenders can get borrowers pre-approved for a mortgage in just a few days, but the actual approval process is an average of 30-50 days.

Conversely, approval for a construction loan can be quicker but more comprehensive. The borrower will likely ask to see details about the planned construction project, including timetable, budget, and possibly a blueprint or rendering of the completed work. They may also inquire about the hired contractor for the project to verify that you are using a licensed and experienced worker.

In many ways, though, approval for a construction loan is just like approval for a traditional mortgage loan. You’ll need to have a credit score of at least 620 and proof of income. You’ll also need a downpayment equal to at least 20% of the total loan amount.

Disbursement of Funds

One of the key differences between a construction loan and a conventional mortgage is how the funds are distributed.

The entire loan amount is paid out in one lump sum when the borrower takes out the loan in a mortgage. This enables the borrower to purchase their new home immediately upon approval.

A construction loan works differently. Instead of the loan amount paid out in one lump sum at the beginning of the loan, funds are paid out in “draws,” or phases, as the construction project progresses. For example, funds may be required after the completion of each of these stages in the project:

  • Delivering the final plans for the home
  • Obtaining permits
  • Completing the foundation
  • Framing out the home
  • Installing all the drywall, siding, windows, and doors
  • Installing HVAC systems, electricity and plumbing
  • Installing interior trims, cabinets, countertops, and flooring
  • Substantial completion of the home
  • Completion of the home