A construction loan is a mortgage loan that is used to help finance a construction project of various types. The loan and appraisal is based on the completed project.
If you are purchasing a property that you will do the construction work on, the loan will be based on the entire project of land cost plus construction cost as well as the appraisal.
If you will be doing the work on a property you already own, the loan will be based on the completed project. The original cost of the property may or may not be a factor. Like a refinance, the construction loan will pay off any mortgage(s) you have on your home.
The loan is a permanent mortgage with a 30 year term (sometimes referred to as a “construction-perm” loan). There is one closing that takes place before construction begins. If you are purchasing the property, the closing would take place at the time you close on the land. There is no second closing once the project is complete.
Any down payment is required at the closing which is prior to construction beginning. As long as you stay within budget, all funds for the construction project will be pulled from the loan during the construction phase. If your budget increases during construction, you may have to make up the difference as items get paid out.
The down payment required (or equity if you already own the property) can vary widely depending on a few factors such as credit score and loan size. Smaller loans with good credit scores allow as little as 5% down (or equity) with the down payment increasing as the loan size increases and credit scores drop.
The payments on a construction loan are interest only during the construction phase based on the balance that you owe. The balance when you close will be relatively low and then as draws are taken on the loan for work complete, the balance on the loan will increase. So the interest only payment will start out relatively low as well and increase as the loan balance increases.
Once construction is complete, the loan moves into the permanent phase and the payment changes from interest only to principal and interest at the same interest rate. There is no second closing and the loan does not balloon or come due. You simply start making regular principal and interest payments.