A construction loan is typically a short-term loan used to pay for the cost of building a home. It may be offered for a set term to allow the borrower the time to build the home. At the end of the construction process, when the house is finished, the borrower will need to get a new loan to pay off the construction loan, sometimes called the "end loan". Banks and mortgage lenders are often leery of construction loans for many reasons. One major issue is that lot of trust must be placed in the builder. The lender is lending money for something that is to be constructed, with the assumption that it will have a certain value when it is finished. If things go wrong, for instance, if the builder does a poor job or if property values fall, then it could turn out that the bank has made a bad investment and that the property isn't worth as much as the loan.
To try to protect themselves from this problematic outcome, banks usually have strict qualifying requirements for a construction loan, including requiring an established qualified builder, lengthy and detailed specifications of building plans, getting an appraisal of the home that doesn't exist yet and requiring a hefty down payment. Once the loan has been approved, the lender then pays the money out in draws. Draws are designated intervals at which the builder can receive the funds to continue with the project, based on different stages of building, and the costs associated with each stage. The number and dollar amount of draws is negotiated between the builder, buyer and lender. Construction loans may have either fixed or adjustable rate, though they are typically structured as variable rate loans.