How does a construction loan work for a new home?

When you borrow money to build a house, there’s no collateral to back up the loan the way there is in a traditional mortgage — at least not yet. This is why there are additional steps involved in a construction loan as opposed to a traditional mortgage. Expect a thorough inspection of the architectural plans and your builder, as well as your finances.

Disbursement of a construction loan also works differently than with a traditional loan. Instead of transferring a lump sum, lenders pay home construction loans to the builder in installments, called “draws.” Each draw coincides with an important phase of the project, such as pouring the foundation, framing and finishing work.

An inspection is required before each draw disbursement to the builder. The amount of the disbursement is based on the work completed.