Why Construction Loans
Should Be a Last Resort

Question: I would like to make renovations on a single-family house that I own as an investment. Can I, as an individual, qualify for a construction loan? What are the advantages and disadvantages of securing this type of financing?

-- Sean, Huntington Beach, Calif.

Sean: Anyone who qualifies financially for a construction loan can get one from a bank. Unlike conventional financing, where all the money is given to the borrower up front, money that is part of a construction loan is doled out a little at a time as work on the project progresses. This protects the lender from a borrower who might otherwise take all the money and not do the work.

As long as you can manage your money, the only reason to get a construction loan is if it is the only loan you can get. Most of the time, it's far better to have all the money up front, ready to be paid out when you need it. With construction loans, lenders often delay making timely payments waiting for paperwork to get completed.

If you have sufficient equity in your house, you should be able to obtain a second mortgage -- also called a home-equity loan -- from a bank for as much as $100,000 in a lump-sum payment. Most lenders will even allow you to draw down on the money as you need it and charge interest only on the amount actually withdrawn.

But if you don't have sufficient equity, lenders often will require that you secure a "home-improvement loan" with holdbacks, which is actually just fancy terminology for a construction loan. You'll have the hassles of needing to provide proof that work has been completed, including sign-offs by local building departments. If necessary, check with a banker into FHA 203(k) and Title I-insured home-renovation loans, which often can provide 100% of the financing you need -- up to defined limits.

-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent book is "Tips and Traps When Renovating Your Home," (McGraw-Hill, 2000).

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