What is the Difference Between a Construction vs. Mortgage Loan?
Chances are, when you hire a home builder in northern Virginia to build your new home, you’ll be taking out a loan of some kind. But what kind of loan do you need for building a new home?
Construction Loans
A construction loan is a form of temporary financing used to fund the building of a new home. The loan money is disbursed in installments called “draws.” During construction, your payments on the loan cover the interest only.
Construction loans often have higher interest rates than mortgages because there is no finished home to serve as collateral. You may also have to make a larger down payment than you would with a mortgage.
When the home is complete, you must repay the loan in full. Most buyers obtain a mortgage to pay off the construction loan. With this process, you’ll have a closing on the construction loan before building begins, and then another closing on the mortgage after the home is built. You’ll have to pay closing costs both times. You’ll also have to apply and qualify for the mortgage after the home is complete.
Mortgages
Unlike a construction loan, a mortgage provides the total loan amount up front. Most mortgages are repaid over many years, usually 15-30, although you can pay it off sooner.
In order for a lender to issue a mortgage, there must be a completed home to serve as collateral. Therefore a mortgage alone can’t be used to finance a home building project. The solution is a combination loan.
Combination
Financing for a home build and purchase can be combined into a single-close construction mortgage, also called a construction-to-permanent loan. It functions as a construction loan during the building process and then shifts into a permanent mortgage when the home is complete. Both loans are combined into one transaction with one closing. This method requires less paperwork and smaller closing costs. You’ll know what to expect because the mortgage terms are finalized before signing. This is the best option for many people looking to build a new home.
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