Using Construction Loans for Homebuilding and Renovations

The idea of building a home that meets all your needs is something a lot of people fantasize about. Maybe you’re already a homeowner and the goal is an accessory dwelling unit—a granny flat, tiny house on a foundation, carriage house, garage apartment, or basement apartment.

Maybe you’ve found a fixer-upper on a perfect plot of land. Or maybe you’ve got a perfect piece of land, and all you need now is the house.

A construction loan could be just the ticket, though a borrower should be aware of the complications of these kinds of loans.

Here’s a look at construction loans and a couple of alternatives.

How Do Construction Loans Work?

When you buy a house, you can finance it with a mortgage. But when you build a house or do a major renovation, getting financing is trickier. Borrowing large sums of money can be difficult when there’s no collateral to guarantee the loan.

Construction loans finance the building of a new home or substantial renovations to a current home.

They are typically short-term, variable interest rate loans designed to cover the costs of land, plans, permits and fees, labor, materials, and closing costs. They also cover contingency reserves if construction goes over budget.

The lender probably will want to check out the builder in addition to vetting your financial situation.

Popular Home Construction Loan Options

‘Construction-to-Permanent’ Loans

Sometimes referred to as “single-close” loans, these are construction loans that convert to a mortgage once the construction is finished.

The borrower typically pays interest only during construction. When the loan is converted to a standard mortgage, the payments are sometimes recast.

The borrower saves money on closing costs by eliminating a second loan closing.

‘Construction-Only’ Loans

Also called a standalone construction loan, this loan must be paid off when the building is complete. You will need to apply for a mortgage if you don’t have the cash to do so.

Having separate construction and mortgage loans allows homeowners to shop for the best terms available when applying for each loan, but they will pay closing costs with each loan.

Renovation Construction Loans

These are specifically designed to cover the cost of substantial renovations (or the cost of improving a fixer-upper). The loans get folded into the mortgage once the project is complete.

Once you are approved for a construction loan, you are put on what’s called a “draw schedule,” based on your construction timeline. Funds will be disbursed directly to your builder to cover the cost of each stage of construction—usually after a lender representative pays a visit to make sure everything’s on schedule.

What Are the Requirements for a Construction Loan?

It’s typically harder to get a construction loan than it is to secure a mortgage. Some people even hire construction loan brokers to facilitate the process. Because your house or ADU isn’t built yet, there’s no collateral. And because there’s no collateral, lenders will want to see strong evidence that the home will be completed.

If it’s a renovation, the lender wants to see that the project will add to the value of the home. Check out SoFi’s Home Project Value Estimator to get an idea of how much value you could get in return for each renovation project.

In order to get approved, you’ll have to show your potential lender an overview of your financial profile, with plenty of documentation. They’ll typically want to see a debt-to-income ratio of 45% or lower and a high credit score.

For new construction projects, they’ll also want you to be able to make a down payment of up to 30%. And for construction-only loans, they may want to know what your repayment plan is—that is, whether you will pay in cash or refinance when the project is complete.

In addition, the lender will want a detailed plan, budget, and schedule for the construction. Some lenders will also need to approve your builder. Because the project will depend on the builder’s ability to complete the construction to specifications, your builder’s reputation may be crucial to getting a construction loan approved.

Lenders typically need to see a builder’s work history, proof of insurance, blueprints and specifications for the project, a materials list, and your signed construction contract.

What Are the Average Interest Rates and Terms?

Typically, construction loan rates rise and fall with the prime lending rate, but they tend to be higher than conventional mortgage rates.

The terms also vary. A construction-only loan usually must be paid off in one year or less, unless the homeowner obtains a mortgage to secure longer-term financing.

A construction-to-permanent loan will typically have a term of 15 to 30 years once it becomes a permanent mortgage. Again, though, the interest rate will usually be higher than a conventional loan because of the increased risk. The longer the term, the higher the rate tends to be.

Are There Alternatives to Construction Loans?

A lot of time and effort may go into securing a construction loan. It can be difficult to find lenders that offer competitive rates and to qualify for them—particularly if you don’t have a flawless credit history.

Plus, they tend to be complicated because it is often the builder who has to carry the loan.

If you are planning a small construction project or renovation, there are a few financing alternatives that might be easier to access and give you more flexibility.

Two are a personal loan and a cash-out refinance.

Personal Loans for Renovations

personal loan can fund a renovation project or supplement other construction financing. It can be much faster and easier to secure than a construction loan.

A home improvement loan also may cost less in interest than a construction loan, depending on your financial profile. And you can frequently choose a personal loan with a fixed interest rate.

Personal loans also offer potentially better terms. Instead of being required to pay off the loan as soon as the home is finished, you can opt for a longer repayment period.

The drawbacks? You won’t be able to roll your personal loan into a mortgage once your renovation or building project is finished.

And because the loan is disbursed all at once, you will have to parse out the money yourself, instead of depending on the lender to finance the build in stages.

Cash-Out Refinance for Construction Costs

A cash-out refinance is also a good financing tool, particularly if you have a lot of equity in your current home. With a cash-out refinance, you refinance your home for more than you owe and are given the difference in cash.

To use a cash-out refinance to cover the cost of construction, you can estimate your building or renovation expenses with this Home Improvement Cost Calculator and then refinance for that amount more than you owe on your home. Then you can put the additional cash from the refinance toward the building project.

Using one—or both—of these alternative financing tools may help you avoid some of the hassle and expense that come with construction loans.

The Takeaway

Planning a new home, granny flat, or substantial renovation? A construction loan may be the ticket, though these kinds of loans are usually harder to secure than mortgages, often carry a higher rate, and are typically short term. For smaller projects, a personal loan or cash-out refinance could be a good option.

Check out SoFi’s personal loan and cash-out refinancing options and get a rate quote within minutes.

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Here’s How To Refinance A Mortgage (And Know If It’s Right For You)

Over the past decade, mortgage refinancing has grown in popularity. Not that big of a surprise, considering we’ve seen a sizable drop in mortgage rates during this time. At the height of the housing crisis in 2008, rates averaged about 6% for a 30-year fixed-rate mortgage .

Currently, the average rate for a 30-year fixed mortgage is about 3.26% , which gives some folks the opportunity to save some serious moola by lowering their interest payments. If you signed on for a higher rate years ago or your financial situation has improved, refinancing is worth considering.

Refinancing a mortgage might not be right for every homeowner, but starting to look at rates and terms could be the first step to being able to save for other financial goals. Here’s everything you need to know about refinancing a mortgage from how to start the process, to figuring out if it’s right for you.

How much does it cost to refinance a mortgage?

Since you’re essentially applying for a new loan, there will most likely be fees if you choose to refinance. Because of this, it’s important to consider those costs compared to the potential savings. A good rule of thumb is to be certain you can recoup the cost of the refinance in two to three years—which means you shouldn’t have immediate plans to move.

Refinancing will generally cost from 3% to 6% of your loan’s principal value, though you should be sure to shop around to make sure you’re getting the best deal.

There are helpful online calculators for determining approximate costs for a mortgage refinance. Of course, this is only an estimate and all lenders are different. The lender will provide final closing cost information alongside a quote for your new mortgage rate.
When you refinance, you also have to consider closing costs. Some lenders may not have origination fees, but instead charge the borrower a higher interest rate.

If you have a great borrowing history and a strong financial position, there are some lenders, like SoFi, that reward such borrowers by offering competitive rates and no hidden fees.

Mortgage RefinancingMortgage Refinancing

What are the steps in the mortgage refinancing process?

The first (and arguably most important) step is to determine what you want to get out of your mortgage loan refinance. There are several mortgage loan types, but “rate and term” and “cash out” are the two most common.

Just as the name implies, a “rate and term” refinance updates the interest rate, the term (or duration) of the loan, or both. You can also switch from an adjustable rate to a fixed rate and vice versa.

It is important to understand that not every refinance will save you money on interest. For example, if you extend the loan terms, you may end up paying more money over the course of your loan.

to boost your credit score. 1
2. Research your home’s approximate value. Check comparable sale prices—not just listing prices—in your neighborhood to get an idea of what your house is worth. If the value of your home has gone up significantly and improves your loan-to-value ratio (LTV), this will be helpful in securing the best refinancing rate.
3. Compare refinance rates online. Don’t forget to ask about all costs involved. Most financial institutions should be able to give you an estimate, but the accuracy can depend on how well you know your credit score and LTV ratio.
4. Get your paperwork together. The process will move faster if you have your pay stubs, bank statements, tax filings, and other pertinent financial information ready to go.
5. Have cash on hand. You may have to pay some up-front costs, like property taxes and insurance.
6. The lender will (mostly) take it from here. They will send an appraiser for a home inspection. After the loan documentation and appraisal are submitted, loan officers determine the interest rate and create the loan closing documents. The closing is then scheduled with the refinancing company, mortgage broker, and real estate attorney.

How long does a mortgage refinance take?

The process can take anywhere from 30 to 90 days, depending on your diligence, the complexity of the loan, and the efficiency of the lender or broker.

If you want the process to move fast, look for mortgage lenders who are looking to disrupt the traditional mortgage process by offering a more streamlined service and a better customer experience.

If you’re like most people, you’ve got a life to live and don’t want your mortgage refinance to drag on for months. Keep this in mind while looking for a lender to refinance with.

Ready to check out your mortgage refinance rates with a competitive lender that values your time? SoFi can give you a quote (that won’t affect your credit score! 2) in as little as two minutes.

1. Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit.
2. To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.

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The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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Cash-Out Refinance vs Home Equity Line of Credit

Cash-out refinances and home equity lines of credit are two borrowing options that allow homeowners to tap into the equity they have built in their home.

A HELOC is a line of credit secured by the borrower’s home. The line of credit can be accessed on an as-needed basis, up to the borrowing limit. The borrower is only charged interest and responsible for repaying the amount they actually borrowed.

For a cash-out refinance, the borrower takes out an entirely new mortgage while borrowing a portion of their existing home equity. The total borrowed amount of the cash out refinance will be greater than the borrower’s original mortgage, and the borrower will receive the difference in a lump sum payment from the lender.

Mortgage RefinancingMortgage Refinancing

Borrowers should keep in mind that a cash-out refinance replaces their current mortgage and even though they receive additional cash they only have to make one monthly payment. Unlike a home equity line of credit, a cash-out refinance may have a fixed interest rate, meaning that the interest rate remains unchanged for the life of the loan so the monthly payments remain the same. Additionally, interest rates are typically lower than with a HELOC.

The approval process for a cash-out refinance is similar to the initial approval process when buying a home. It can be somewhat cumbersome, but the payoff is a lower interest rate, a fixed payment, and access to additional cash.

Which is better: Cash-Out Refinance vs Home Equity Line of Credit?

Like most things in the world of finance, the answer to which option is better will vary by person based on their individual financial circumstances and unique needs. In some situations, a HELOC may make more sense than a cash-out refinance and vice versa.

HELOCs can be useful for shorter-term needs or situations where a borrower may want access to funds over a certain period of time, for example when completing a home renovation. Because HELOCs generally have a variable interest.

Cash-out refinances can make sense if there is a need for a large sum of money or if they can be used as a tool to improve your financial situation on the whole.

Both a home equity line of credit and a cash-out refinance have fees associated with them. With a cash-out refinance, fees are paid upfront in the form of loan closing costs. With a HELOC, several types of fees can be charged periodically such as an annual fee or inactivity fee for non-usage. One way for a borrower to reduce these fees is to shop around and compare lenders. for details.