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Oh Joy! Builds a House: Construction Loans!

Explaining Construction Loans / Oh Joy!

Explaining Construction Loans / Oh Joy!

This might be the most exciting day of your life because I am holding a TON of piggy banks about to talk about LOANS! But seriously, I am VERY excited to discuss this topic with you because there are lots of misconceptions about how anyone can afford to build a house. The answer is…most people do it with loans! I was completely overwhelmed by this process when I started, but I have since learned SO much and want to share that with you…

Here's what most people think about paying for a huge home project (a custom build or major renovation):

A. You need all cash to build a house. (NOT TRUE. I don't have cash just lying around, and here I am doing this crazy project!)
B. You need to have saved up a lot of money. (SORT OF TRUE. You do need to have some savings to be able to qualify and provide a down payment to close a loan. The amount of the down payment will vary, but could be up to 20-25% of your loan amount. However, things like owned land can be used as equity towards this down payment.)
C. You can use a credit card to pay for a home renovation. (NOT A GOOD IDEA. Credit card interest rates are much higher than a loan and unless you are using a credit card to help your overall credit, get points on your credit card, and then pay off each month in full, then don't do it.)

Mortgages vs. Construction Loans
You may already be familiar with mortgages if you've ever bought a home or are in the market for a home. A mortgage is a loan you can get to buy an existing house that you pay back over time (10, 15, 30 years, etc.). The amount of the mortgage you are given is based on your financial credit, cash flow, income, and the value of the home you want to buy. Construction loans are similar but also different. If you do Google search for "Construction Loans", you will get a ton of information about it. All of that information can be overwhelming and confusing, so I wanted to explain how they work from my experience over the last couple years.

Essentially, Construction Loans can be used to build a house from scratch or to do major renovations on an existing house.

Explaining Construction Loans / Oh Joy!

Here's how a Construction Loan works:

1. In order to qualify for a Construction Loan, you need to first be approved for a Mortgage. The Construction Loan that you could get will eventually turn into a Mortgage when your renovation work or your new home is finished. So if you don't already have a mortgage, a bank needs to work backwards and first approve you for the Mortgage that you will eventually be paying off over time. This process is the same as applying for a Mortage, except that even if you are approved for the mortgage, it's not guaranteed you will be approved for a construction loan. You still need to go through additional steps to qualify.

2. A bank will usually lend you 70-80% of the value of your finished home. So, hypothetically (with made-up numbers here), if your finished home will be valued at $100,000, the bank can approve you for $70-80K in a construction loan. In some cases, that amount could completely cover the cost to build or renovate your home. But, let's say your work will cost $85K and the bank can only lend you $80K, you will need to come up with the difference of $5K to get approved for the Construction Loan (in additional to standard financial paperwork). Now, if you already own a home with a mortgage and looking for a Construction Loan for major renovations, your current mortgage will get factored into how much a bank can lend you for construction.

3. In a Construction Loan, the bank pays the contractor — not you. So, let's say you do in fact get this hypothetical $80K from the bank to cover the cost of your construction. Once the work starts, your contractor would request draws from the bank regularly (usually monthly) by providing a record of what work was done and what funds are being requested to be paid for. The contractor sends a "draw request" to you, you sign off on it, and then the bank pays that amount to the contractor. Sometimes the bank will send someone out to your project to make sure that work has, in fact, been completed before paying that amount. This process happens monthly until the project is completed. This is when a qualified and organized contractor comes into play because their ability to stay on schedule and complete the work that they are asking to be paid for will be reviewed by the bank regularly in order to get each phase of the project paid for.

4. Once building is complete, home construction loans are either converted to permanent mortgages or paid in full. Depending on your type of construction loan, you have either decided you will pay off the cost of your construction by the time the project is done. Otherwise, the money that you borrowed from the bank to pay the contractors now turns into a mortgage which you will pay off over time just like any other mortgage.

Now, keep in mind, I am not a bank nor am I a finance person. This explantation is a "101 of Construction Loans" and how I would explain it to a friend or family member asking me about it. But, if you have any other questions…please feel free to ask in the comments below and I will do my best to answer!

You can see more over at my post on Architectural Digest's Clever to see the details on what a Construction Loan can cover.

{Photos by Lily Glass. Styling by Wilmarose Orlanes, styling assistance by Jess Hong.


  1. We started to built our home roughly about 6/7 years ago. At the time, a construction loan was practically impossible to get (most banks stop offering that type of loan) and if there was a bank who had the product, the rates were incredibly high. Is that not the case anymore? Also, did you shop around for rates or were there pretty similar standard? Lastly, did you go with a mainstream bank (Chase, Wells, BofA, etc) or a smaller bank? I’d love to build another home and a construction loan would totally make it possible.

  2. Rebekah,
    Construction Loans are still not super easy, but I do think it’s a bit better than when you must have tried 6/7 years ago because the economy got better and therefore construction has been on the rise.
    We did shop around to a few banks and ended up working with Bank of the West. They have been amazing to work with. The rates varied throughout our process of applying and it took a long time (about a year) to finalize paperwork because we had to wait on permits and other factors to close the loan. But we ended up with a reasonable rate!

  3. Question – for things like fixtures and appliances that you will need complete the loan – are you running that through your general contractor so that the loan pick sip the cost of those or are you paying out of pocket for things like: oven, refrigerator, kitchen cabinet knobs, etc?

  4. Gracie,
    Great question! For those items, we are personally getting them separately. Some contractors can include that into their quote and be responsible for purchasing them. But since I have my own contacts and designer discounts through my job, I wanted to be able to order and supply those items myself for them to install.

  5. How do you factor in buying the land to build on? Do you get a separate loan for that, or does that value get bundled up with the construction loan to make one big mortgage in the end, or do you just need to own the land outright?
    I’m so excited to keep reading this series, my husband and I have dreamed of building our own home for years!

  6. Aly,
    It’s ideal to own the land outright. In our cash, we used the money we were saving on a down payment for a home to buy the land. Some people do lump their land into their construction loan, but it’s harder to get the construction loan with the land included as the bank wants to be able to use the land as collateral which they can’t do if you don’t own it.
    Thank you!

  7. It’s also good to find a loan provider that can supply budgeting software with your loan if you don’t have your own. Expenses can get out of control if you don’t watch things with a fine tooth comb or prepare for unforeseen emergencies.

  8. Hi! I’m trying to understand the first steps in the process. Do you hire an architect and have a contractor give you a quote before you apply for a construction loan? Or do you apply for a loan first and work within that budgeted amount?

  9. Hi Clariza,
    Typically, you can’t get an estimate for the construction until you have plans from an architect. So the architect fees don’t typically come out of the loan.
    The loan is often used to cover construction costs since that’s the bulk of the costs so it’s helpful to get an estimate from a contractor (or several) to have an idea of building costs. You can use an estimate to apply for your loan, see what you can get, and then decide on the contractor after that.
    Hope that helps!

  10. We just built a house with a construction to permanent loan. Shop around for builder and lender. Ask friends, family, and co-workers. Don’t let anyone rush you. If you have a bad feeling, walk away and try someone else. Have your lawyer go over everything. Read the FINE print.

  11. Hi Joy,
    We are on day -30 of our building journey. We just bought a property that we will demolish to build a new modern home. Thank you for your blog. Are you comfortable sharing the contact details of your Bank of the West loan officer? We are looking into several options now and would like to explore this one. It’s always easier to speak to a referral. Thank you for considering. Kate (and Ben)

  12. Hello Joy!
    Can you share how the bank estimates the future value of the home (the basis of the 70-80%)? Do they have someone appraise the architects plans? Do they include the value of the land purchased?
    Thank you again for sharing this! This totally demystified construction loans for me.

    1. Hi Sha! The bank sends an appraiser to look at the land as well as the plans. They evaluate comps in the neighborhood as well to determine the value. The will reappraise after the house is done and before the construction loan turns into a mortgage and usually the value goes up more from there once there is a complete new home to see.

  13. I found this article to be very informative and well-written. Thank you for sharing your insights and expertise on this topic. I look forward to reading more from you in the future.


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