If you’re about ready to tackle your first major renovation or even buying a tear down and tearing it down, you’ll likely need a construction loan or rehabilitation loan in the interim, before you obtain permanent financing.

Construction loans are short term, just long enough to cover the construction. Oncenew construction construction has been completed the construction lender will want its money back and you can either pay the loan back in cash or do what most do and obtain a conventional mortgage to replace the construction note. But conventional and construction loans work a bit differently.

Both require that you be credit approved as well as being able to afford the monthly payments and so on. A construction loan is no different than a permanent mortgage in this regard. The difference is in now the loan plays out after an approval has been received. With a permanent mortgage, you and the property are approved and the property must be approved as well.

With a construction loan, the bank will hire an appraiser who will review the plans and specifications and the builder’s cost to construct. The appraiser will assess a value as if the property has already been completed by comparing similar existing homes in the area with the one to be built and will generally lend up to 80 percent of the final appraised value. If the “as completed” value is $300,000 then the bank will issue a $240,000 construction loan which will be distributed at various milestones as the property is under construction. What the bank will not do is simply hand the builder a check for $240,000. That could be a bit dangerous.

As each milestone is completed, the bank orders an inspection to confirm the work has indeed been finished and the builder then moves onto the next phase, with a partial payment from the bank in hand. At the end of construction, there will be one final inspection making sure the home has been finished. Now it’s time to replace the construction note with a permanent mortgage.