Conventional and Owner Builder Construction Loan Interest Rates Compared

The construction loan interest rates for both conventional and owner-builder construction loans have a few similarities, but each loan's features also bring some important differences in their interest rates. 

The Similarities 

Both conventional and owner-builder construction loans are based on the national prime rate.  Both loans also have two different pay periods, during the construction phase, you will have a fixed rate, and will make interest-only payments on the money drawn against the loan to date each month.  Then once your home is built, your loan will be converted to a more conventional home loan, and your rate will be recalculated based on the market value of your new home.  You will have the option to change from a fixed rate to a variable rate, if you would prefer one. 

Despite these similarities, the differences between a conventional loan and an owner-builder construction loan also make for differences in the interest rates. While both loans are based on the prime rate, the owner-builder loan rates tend to be higher than a conventional construction loan during the construction phase.  Then, during the second phase, the interest rate for the owner-builder loans tend to be lower than the rates for a conventional construction loan.  

Why Are Owner-Builder Construction Interest Rates Different? 

Lenders usually set a higher interest rate for the construction phase for owner-builder loans because they consider them to be much riskier loan.  With a conventional loan, a general contractor oversees the construction, and since a general contractor has experience in construction and is more likely to stick to the construction plan, a lender can be more certain that a borrower will not default, and can set a lower interest rate.  

However, with an owner-builder loan, the homeowner himself is the general contractor for the project.  Even though lenders require owner-builder loan borrowers to prove they have some construction experience, there is still a risk of a borrower’s expenses getting out of control or the project running too long.  High costs or long construction period can lead to high default rates.  Lenders will charge higher interest rates during the initial construction process for owner-builder loans to protect themselves.  

During the second phase of the loan, the interest rate is based on the prime rate, but also on the equity of the home itself.  With a conventional construction loan, the equity is based on the market value for what your home would be worth if you were buying it already built.  But with an owner-builder construction loan, the interest rate is based not only on the market value, but on the actual costs of construction.  A lender considers the difference between the actual construction costs and the market value of your home as an automatic down payment towards your loan.

For instance, if your new home’s market value is $300,000, but the construction costs were only $260,000, your lender will consider that $40,000 difference as an automatic $40,000 down payment on your home.  Since owner-builder loans have these savings built in, lenders can offer a lower interest rate during this second phase of the loan.