What type of loan is typically used for home construction?

A construction loan is specifically designed for funding the building of a new home or major renovations. Unlike traditional long-term mortgages that are based on the value of an existing home, a construction loan is short-term funding that provides capital as the construction progresses. These loans often cover the cost of materials and labor and are typically drawn down in stages based on project milestones, such as completion of the foundation or framing.

Once the construction is complete, the borrower generally needs to refinance the construction loan into a permanent mortgage, which will have a long-term structure and fixed payments. This makes construction loans distinct from long-term mortgages that are used to finance already completed properties, and they differ from home equity loans that leverage the equity of an existing home for borrowing.

Construction loans also typically have higher interest rates due to the increased risk that lenders perceive with unfinished structures and the dependence on construction timelines. Thus, for anyone looking to finance home construction, a construction loan is the appropriate choice.