The first type of construction loan is a construction-only loan. With this loan, the lender will offer an amount of money that will cover the cost of the construction project. The borrower is typically able to make interest-only payments on the loan until the project is complete, or for a specified time, usually one year. The principal balance is commonly due in full once the project is complete, or one year later. This allows the borrower the freedom to apply for a mortgage with another lender once the project is complete.
The construction-to-permanent mortgage loan covers the cost of the construction project and the mortgage on the completed property. An interest-only payment option may still be available with this type of loan, typically for one year. There is only one closing with this type of loan, because the borrower will be working with the same lender for the construction and the mortgage. The interest rate is usually different for the duration of the construction, and will change once the mortgage payments begin. There may be a penalty if construction exceeds one year.