Construction Loans

What Is a Construction Loan?

A construction loan is short-term financing used to cover the cost of building a new home. Unlike a standard mortgage, funds are disbursed in stages - called “draws” - as construction progresses, and you only pay interest on the amount drawn so far.

Once the build is complete, the loan either converts to a permanent mortgage automatically (one-time close) or is paid off with a separate mortgage (two-time close). Construction loans are more complex than standard home purchases, but they’re the only way to finance a custom home build.

The key difference from a traditional mortgage: instead of buying an existing home, you’re financing a home that doesn’t exist yet. The lender is underwriting both you as a borrower and the construction project itself - including the builder, the plans, and the budget.

Types of Construction Loans

There are several construction loan structures, each with different advantages. The right choice depends on your situation, your builder, and your long-term financing preferences.

Construction-to-Permanent (One-Time Close)

The most popular option and typically what we recommend. You close once, the loan funds construction through draws, and then automatically converts to a permanent mortgage (conventional, FHA, or VA) when the home is complete.

Advantages:

• One closing, one set of closing costs
• Lock your permanent rate upfront (protection against rate increases during construction)
• Simpler process - no need to requalify for the permanent loan

Best for: Most buyers building a custom home who want predictability and lower total costs.

Construction-Only (Two-Time Close)

A standalone construction loan that must be paid off or refinanced into a permanent mortgage when construction finishes. You’ll close twice - once for the construction loan and again for the permanent mortgage.

Advantages:

• Flexibility to shop for the best permanent loan terms after the build
• May offer lower construction-phase rates

Drawback: Two sets of closing costs, and you must requalify for the permanent mortgage - if your financial situation changes during construction, this creates risk.

FHA Construction Loan

For buyers who want the lower down payment and credit flexibility of an FHA loan combined with construction financing. This is a one-time close program that allows:

• 3.5% down payment (calculated on total project cost)
• Credit scores as low as 580
• The loan converts to a standard FHA mortgage upon completion

VA Construction Loan

Eligible veterans and active-duty service members can use a VA loan for construction, combining the VA’s zero-down-payment benefit with construction financing. Fewer lenders offer this program, but it’s an exceptional benefit for those who qualify.

Construction Loan Requirements

Construction loans have stricter requirements than standard mortgages because of the added complexity and risk.

Credit Score

Most construction loan programs require a minimum credit score of 680. FHA construction loans can go as low as 580. The higher your score, the better your rate during both the construction and permanent phases.

Down Payment

Down payments range from 5% to 20% depending on the program. The down payment is calculated on the total project cost - land plus construction.

Program	Min. Down Payment	Min. Credit Score
Conventional Construction	10-20%	680
FHA Construction	3.5%	580
VA Construction	0%	Varies (580+)

Builder Requirements

Your lender will need to approve your builder before the loan closes. This typically means the builder must:

• Be licensed and insured in the state where you’re building
• Have experience with similar projects
• Provide a detailed construction contract, plans, and specifications
• Provide references and financial statements

Important: Most lenders will not approve owner-builder projects (building the home yourself). You’ll need a licensed general contractor.

Land

If you already own the land, your equity in it often counts toward your down payment. If you need to buy land, many construction-to-permanent loans can roll the land purchase into the loan - financing everything in one package.

How the Construction Draw Process Works

This is where construction loans differ most from standard mortgages. Instead of receiving the full loan amount at closing, funds are released in stages as the builder completes milestones.

Typical draw schedule:

1. Foundation - first draw after the foundation is poured and inspected
2. Framing - released when the structural framing is complete
3. Rough-in - after plumbing, electrical, and HVAC rough-ins pass inspection
4. Drywall and interior - when interior walls, flooring, and fixtures are installed
5. Final draw - after final inspection and certificate of occupancy

Before each draw, the lender sends an inspector to verify the work is complete. This protects both you and the lender from paying for unfinished work.

During construction, you make interest-only payments based on the amount that’s been drawn - not the full loan amount. So your payments start small after the first draw and increase as more funds are released. Full principal-and-interest payments begin when the loan converts to its permanent phase.

Construction Loan Rates

Construction loan rates are typically 0.5–1.5% higher than permanent mortgage rates because of the added risk and complexity. Here’s what to expect:

During construction: Interest-only payments on the amount drawn. If your construction loan is $400,000 and $100,000 has been drawn, you’re paying interest only on that $100,000.

After conversion: The loan converts to a permanent mortgage at the rate locked at closing (one-time close) or the rate you qualify for at that time (two-time close).

With a one-time close construction-to-permanent loan, you lock your permanent rate upfront - which protects you if rates rise during the 6–12 months of construction. This is a significant advantage in volatile rate environments.

Construction Loan vs. Renovation Loan

If you’re buying an existing home that needs significant work rather than building from scratch, a renovation loan may be the better fit.

Feature	Construction Loan	Renovation Loan (203k/HomeStyle)
Purpose	Build new from ground up	Renovate existing home
Minimum Down	5-20%	3-3.5%
Builder Required	Yes (licensed GC)	Yes (licensed contractor)
Timeline	6-12 months build	Varies (1-6 months typical)
Complexity	High	Moderate
Draw Process	Yes	Yes (for major renovations)

Renovation loans like the FHA 203(k) or Fannie Mae HomeStyle let you finance both the purchase and the renovations in a single mortgage. They’re simpler and more accessible than full construction loans, but they require an existing structure.

How to Apply for a Construction Loan

Step 1 - Find and vet a builder. Get licensed, insured contractors with proven track records. Get detailed bids and construction timelines. This is the most important step - your lender must approve your builder.

Step 2 - Develop plans and cost estimates. Work with your builder (and architect if needed) to create detailed plans, specifications, and a line-item budget with 5–10% contingency for overruns.

Step 3 - Secure your land. Own it outright, have a purchase contract, or plan to roll the land purchase into the construction loan.

Step 4 - Get pre-approved. Book a consultation to review your financial profile, builder documentation, and project plans. We’ll determine which construction loan program fits your situation.

Step 5 - Appraisal. The appraiser estimates the home’s future completed value based on the plans and specifications - this is called a “subject to completion” appraisal.

Step 6 - Close and begin building. After closing, your builder begins work and requests draws at each milestone. You make interest-only payments during construction.

Step 7 - Final inspection and conversion. Once the home passes final inspection and receives a certificate of occupancy, the loan converts to your permanent mortgage. Full P&I payments begin.

Not sure how much home you can afford? Use our affordability calculator.