Construction Loan vs Mortgage: What's the Difference?
Why a construction loan behaves nothing like the mortgage you're used to.
A mortgage buys something that already exists. A construction loan pays for something as it gets built. That single difference drives everything else about how the two behave.
Side by side
Construction loan
- Term: short, typically covering the build period
- Funding: released in draws as work is completed and inspected
- Payments: usually interest only, on the drawn balance
- Collateral: land plus a house that doesn't exist yet, which is why underwriting is stricter
- Rate: often variable during construction
- Oversight: the lender inspects before releasing each draw
Mortgage
- Term: long, typically 15 to 30 years
- Funding: the full amount at closing
- Payments: principal and interest from month one
- Collateral: a finished, appraisable house
- Rate: commonly fixed
- Oversight: none after closing
Why construction loans are harder to get
The lender is lending against an appraisal of something that isn't built. They mitigate that with tighter credit standards, larger down payments, approval of your builder and your contract, and draw inspections. It's not personal, it's collateral risk.
The three ways people combine them
- Construction-to-permanent. One loan that converts. One closing. See the full explanation.
- Construction-only, then a separate mortgage. Two loans, two closings, two sets of costs, and you re-qualify at the end. It gives you the freedom to shop the permanent loan, at the cost of certainty.
- Lot loan, then construction financing. If you're buying land well ahead of building. See lot loans.
The risk to understand with construction-only
You have to qualify twice. If your income, credit or rates change during a nine month build, the mortgage you assumed you'd get at the end is not guaranteed. Construction-to-permanent removes that risk, which is a large part of why it's the common choice.