How does a construction loan work?
In: Economics
Most loans works with you putting up some sort of object as security to get better interest, for example a car in a car loan or a house in a mortgage or even anything in the case of a pawn shop loan. The better interest rate comes from the fact that if you do not pay the loan then the lender will take ownership over the security and are free to sell it to pay back the loan for you.
A construction loan is similar but also slightly different. In this case you do not actually own the house yet, only the land. But you need a loan to start building your house. So in a construction loan you are essentially putting up your unbuilt house as security for the loan. It does require a bit more paperwork to sattisfy the bank and usually involves the construction company having to make promises to the bank as well. The bank is risking that you may build a house that have a much lower market value then the loan which means the bank can lose money. Usually the construction loan gets converted to a normal mortgage once the house is finished. It is also possible to get a construction loan for renovations to an existing home.
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