If you’re planning on building your home, obtaining a construction mortgage is necessary. Lenders will review your credit score and debt-to-income ratio to make sure you can afford the costs of new home construction.

Construction mortgages come in two varieties, stand-alone and construction-to-permanent loans. Both require higher down payments and more stringent eligibility standards than regular mortgages.

It’s cheaper to build than to buy

Over one third of states offer more cost savings when building than when purchasing, although construction may take several months longer and taxes will likely remain higher until they’ve been reassessed.

Construction loans only require you to pay interest during the building process, with lenders dispersing funds in installments known as “draws”. An inspector or appraiser will visit regularly to monitor progress and approve these advances; when your construction project is completed, either pay back your loan in full or convert it into a mortgage loan.

Rates for construction loans tend to be higher than for traditional mortgages, though you may find lenders offering zero- or even low-interest options. You can compare prices and terms from various lenders before finding the most advantageous loans. Staying up-to-date on everything money related? Subscribe to CNBC Select; we’ll send expert tips, strategies, and news directly into your inbox!

It’s easier to qualify for

Home construction loans can be more complex to qualify for than traditional mortgages, requiring not only higher down payments and stricter credit criteria.

As part of the building process, lenders disburse funds in increments called “draws”. Draw amounts are only released once a certain phase has been completed and an inspection performed to check on progress. Builder payments during construction period include interest payments; once construction period ends, borrower can either roll their loan into permanent mortgage or pay off principal.

Another option for paying off construction loan principal is taking out a separate mortgage; however, this could prove costly as two separate applications and sets of closing costs need to be submitted and paid. Furthermore, an independent mortgage could increase costs through higher interest rates.

It’s more flexible than a traditional mortgage

At the conclusion of your construction period, your lender can automatically convert it to a permanent mortgage and reduce interest rate risk. Furthermore, loan terms can even extend beyond one year should that be necessary.

To be eligible for a construction-only loan, it is important to meet the lender’s credit requirements. They may also review your builder to ensure they are licensed and insured before asking for down payments and detailed blueprints of what home you plan to build – as well as an itemized budget plan of expenses associated with this new endeavor.

If you are a contractor or homebuilder working on your own, an owner-builder loan could help reduce costs by eliminating third-party contractors and saving time. Lenders typically require high down payments as well as excellent personal credit scores to prove that you can be trusted to manage a project successfully.

It’s more risky for the lender

Before selecting a lender to provide them with a construction loan, borrowers should conduct thorough research. Lenders typically review financial documents such as bank statements, tax returns and credit reports in order to evaluate a borrower’s financial strength as well as reviewing details like timelines and budgets of projects in progress as well as checking up on contractors to ensure they can complete them within an estimated timeline.

As home construction loans are considered riskier investments for mortgage lenders, their interest rates tend to be higher than traditional mortgages and require larger down payments and stricter borrower requirements. Borrowers should carefully evaluate their finances to see whether they can afford this higher rate – otherwise it would be wiser to wait until they can obtain permanent financing instead. A TD mortgage loan officer can explain all types of construction loans and assist you in selecting one tailored specifically to your situation.