How Is a Construction Loan Different From a Mortgage?
If you’re in the market for a new house, odds are that you need a loan to help pay for it. And in that search, you might have come across two different types of loans: mortgage loans and construction loans. While they both cover the costs for a new home, they do differ in several areas such as:
- What kind of houses you can use them for
- When you receive the funding
- Payoff periods
We cover these differences and provide more details on a construction loan vs a mortgage from Indiana Members Credit Union (IMCU) throughout this blog.
What Is a Construction Loan vs a Mortgage?
A construction loan is one that you use to pay for a house you are building. That money can go towards inspections, materials, land, contractors, and whatever else you need to complete the project. Mortgages only pay for houses that already exist. So if you’re interested in building your future home, you will have to choose a construction loan. Both types can be used if you’re adding onto an existing home.
Because these two loans differ in the houses they cover, they also vary in when you can use that money, requirements to receive them, and how long they last. Let’s take a closer look at each difference between a construction loan and a mortgage:
- When you can use the money: When you take out a mortgage, the full amount of the loan is applied at closing. However, only a little bit of a construction loan is applied at a time. That’s because your lender will want to make sure that the construction of your house is going as planned. You will get a portion of your loan at the beginning of each phase of the building process. At the end of each phase, an inspector must come out to check progress before you can continue building.
- Collateral: With a mortgage loan, your house acts as collateral. If you can’t pay back your mortgage, your lender will take your house. With construction loans on the other hand, you do not have to provide any major collateral.
- Interest rates: Construction loan interest rates tend to be higher than those for mortgages since you do not provide collateral for construction loans. With construction loans, you only have to pay interest during the build of your home. You then pay the remaining balance once your house is completed. You can pay it in the form of cash or a traditional mortgage. With a construction-to-permanent loan, it will automatically turn into a mortgage. You have to pay both interest and for part of the loan itself each month when you have a mortgage.
- Down payment: Construction loans tend to require a larger down payment than mortgages since they do not require collateral. That amount is typically 20-30% of the building price whereas the mortgage down payment amount can range from 3-20% of the house’s value.
- Duration: A construction loan typically only lasts one year. That’s because it only pays for the construction of the house itself, which should be completed in a year. You will need a mortgage after your house is completely built. With one type of construction loan, you have to apply for a mortgage separately. With the other type, a construction-to-permanent loan, your construction loan will automatically transition into a mortgage once your house is done. Mortgages take much longer than construction loans to pay off. It typically takes you 15-30 years to do so.
What Are the Requirements for a Construction Loan and a Mortgage Loan?
The requirements for loans on your home vary from lender to lender. However, you typically need:
- A credit score of 680 or higher
- Proof of income
- A down payment
- A debt-to-income ratio of at most 43% once the loan is taken out
Mortgages often have an additional requirement of having home insurance. Construction loans require a detailed plan including how long it will take, how much you’ll spend, contract with the builder, and estimated appraisal amount of the finished home.
Turn to IMCU for a Loan on Your Home
Buying a home is an important step to create a life for yourself. At Indiana Members Credit, we want you to find the house of your dreams. That’s why we have both construction loans and mortgages for whatever that dream looks like.
At Indiana Members Credit Union, we require a minimum FICO credit score for a construction loan of 680. With our construction to permanent loan, you can expect:
- Down payments as low as 5%
- Terms up to 30 years
- Interest only payments during building up to 12 months
If you would rather buy a home that’s already built, you can expect the following from our mortgage options:
- Loan amounts as high as $647,200 (or as high as $2,000,000 with a jumbo loan)
- Terms up to 30 years