What is a construction loan and how does it work?

Construction loans are a specialised type of financing offered by banks and Non-banking Financial Companies (NBFCs) to fund building or renovating real estate projects. The loan disbursal is aligned with the different stages of the construction process.

How do construction loans work?

• The loan applicant must submit a detailed project plan with cost estimates to the lending institution. This plan includes construction blueprints, material and labour budgets, permits, etc.
• The loan amount and tenure are sanctioned based on an appraisal of the plan and the applicant's repayment capability.
• The approved loan is not disbursed all at once. Funds are released stage-wise in tranches (small portions of the sanctioned loan amount) linked to completion percentages - foundation, framing, roofing, fittings etc.
• At each stage, a construction company assessor verifies progress and certifies stage completion before the respective tranche gets credited.
• This ensures funds are utilised only for construction-related expenses and not diverted for other needs.
• Construction loan interest rates are usually higher than other mortgages but vary across NBFCs. Applicants should compare interest rates before selecting a provider.

Once the project finishes, the loan converts into a conventional long-term mortgage with regular Equated Monthly Instalments (EMIs).

Construction loans enable financing of building projects in phases without needing full capital upfront. The payment schedule is aligned with work progress till final completion.