Construction Loans, whether residential or commercial, are essentially short-term loans that finance the "construction" of a property. Once construction is complete, the owner of the property will obtain a standard mortgage and pay off the construction loan. 

Types of Construction Loans  

Great, it's a short term loan.  Got it, but you want to know how they work. There are several types of construction loans. There are single close loans, in which the construction and land financing is done initially and then becomes a standard loan once complete, without having to go back to the closing table. A double close financing entails having to go back to the closing table once construction is complete.

Typically the construction and the permanent loan are financed through the same company. IndyMac Bank, prior to going under, was the nation's premier construction to perm lender. 

Escrow Release

Depending on the bank, the money for financing is often doled out by the bank, step-by-step, as certain goals are met. IndyMac was notorious for upsetting contractors who would have to stop construction while waiting weeks for the next infusion of cash to come from the bank. Other banks will provide a lump sum once they have a cost estimate and blueprints in hand.

Land Financing

Some Lenders will require they finance the land as well, as it's essentially the only collateral they have. A half-built house with a rotting frame will do them no good if it is foreclosed.