Construction loans are typically considered by borrowers when going through the process of building a home from the ground up. In some instances, construction loans can be an option for home renovations. Here, we will look at the different types of construction loans and evaluate the pros and cons of using them for your next remodeling project.

What is a Construction Loan?

Construction loans for renovation are short-term loans that enable homeowners to tackle home projects. Borrowers can also utilize this loan type when they wish to build a new home on a plot of land.

A construction loan closes by finalizing the terms and conditions agreed upon between the lender and the borrower, which typically includes a detailed construction plan and budget. Once the loan is closed and the first draw is funded, the builder can commence work on the project. Subsequent draws are released according to the builder's draw schedule, which outlines specific milestones for construction progress. As each phase is completed, an appraiser inspects the site to evaluate the advancement of the work done. Based on this inspection, the lender determines whether to authorize the next draw, ensuring that funds are disbursed in alignment with the ongoing construction progress. Once the project is complete, the loan is converted into a regular mortgage that the borrower can begin paying off.

Construction loans can cover a variety of costs, including:

• Cost of Land
• Foundation
• Construction Permits
• Building Materials
• Contractor Labor
• Major Appliances
• Closing Costs
• Contingency Reserves

Types of Construction Loans

There are a various types of construction loans that can help you complete your dream home or any other construction project. The different offerings can adjust the payment timeline, closing outcomes, and final rates. Here are the most popular types of construction loans:

Construction-to-Permanent Loan

As the name suggests, this construction loan becomes a permanent mortgage once the project is complete. It is also known as a "single-close loan," because it eliminates the costs of a second closing. Construction-to-permanent loans are typically used for homebuilding.

Construction-Only Loan

This type of loan is also referred to as a "standalone construction loan," because it's a loan that only covers your renovation construction project. When the construction is complete, the loan must be paid off. If a borrower doesn't have the funds to do so, they will need to apply for a mortgage. Construction-only loans are a great choice when you want to shop around, but borrowers should be aware that they'll need to pay a separate closing cost.

Renovation Construction Loan

These construction loans are designed to fund renovation costs from start to finish throughout your entire renovation project. Once the construction is complete, the loan will be enveloped by your existing mortgage. ProFed offers Renovation Loans — click or tap here to learn more. 

Benefits of Using a Construction Loan for Renovations

Some benefits of using construction loans for renovation include:

• First-time buyers can apply for an FHA renovation loan with a down payment of only 3% of the purchase price.
• You can increase the value of your home without having to provide the funds up front.
• It's a great way to build your credit.
• Typically, renovation loans can be paid off over 12 months or longer.
• A borrower can cover the price of their home and renovations with one loan, which makes life easier and lowers interest rates.

Challenges Associated with Renovation Loans

There are some drawbacks to using a construction loan for renovations. They can include:

• They might not be a good option for investment properties such as a fixer-upper (because many loans require that the home be a primary residence).
• When a lender requires collateral, most homeowners use their properties. Late and missed payments can put borrowers at risk of losing their homes.
• Missed payments can hurt your credit score, making it more difficult to make purchases going forward.
• Some lenders require a Mortgage Insurance Premium (MIP).

Consider a Construction Loan with ProFed Credit Union

If you want to learn more about the construction loan process, our experts are happy to provide more information.

Schedule an appointment today, and we'll help you make the best decision for your budget, your financial needs, and your construction plans.