A construction loan works by financing a home build in stages: you close once at the start, the lender releases money in scheduled draws as the work hits inspection milestones, you pay interest only on what has actually been disbursed, and when the local building authority issues a certificate of occupancy the loan either converts into a standard mortgage or gets paid off by a new one. The mechanics around that basic shape depend heavily on which loan structure you choose and how your build actually unfolds.
The Two Loan Structures
Lenders offer two paths, and the choice shapes everything downstream.
A construction-to-permanent loan, often called a single-close loan, bundles the building phase and the long-term mortgage into one transaction. You sign one set of closing documents at the start, and after the house is finished the loan converts into a 15-year or 30-year mortgage without a second closing.1Fannie Mae. FAQs: Construction-to-Permanent Financing That means one round of closing costs, one underwriting process, and one appraisal.
A construction-only loan, or two-close loan, is a stand-alone short-term debt covering only the build. When the house is done, you must pay off that loan in full, which almost always means closing on a separate permanent mortgage. The second closing brings its own title search, appraisal, underwriting review, and fees. Some borrowers prefer this route to shop for the best permanent rate once the home is complete, or because their lender doesn’t offer a single-close product. The tradeoff is two sets of closing costs and the risk that your finances or market rates could change between closings.
How Money Reaches the Builder
Once your loan closes, the full amount doesn’t land in your builder’s account. The lender releases funds through a draw schedule tied to construction milestones. A typical residential build has four to six draws aligned with major phases:
- Foundation: site grading, footings, and poured foundation, usually around 15–20% of the construction budget.
- Framing: structural framing and exterior sheathing, often the single largest draw at 25–30%.
- Dry-in: roof installed, windows and exterior doors set, building weathertight.
- Rough-in: plumbing, electrical, and HVAC roughed in, insulation installed.
- Interior finishes: drywall, cabinets, countertops, flooring, paint, and fixtures.
- Final draw: punch list items complete and certificate of occupancy issued.
Before any phase gets funded, a third-party inspector visits the site to verify the work is actually done and matches the plans. If a phase is only partially complete, the lender releases a proportional amount and holds the rest. Inspections typically take two to five business days after a draw request. This protects both you and the lender from paying for work that hasn’t happened.
Lien Waivers
Each draw request also requires lien waivers from the subcontractors and suppliers who’ve been paid. A lien waiver is a signed document confirming the worker or supplier received payment and gives up the right to file a claim against your property. Without them, an unpaid electrician or lumber yard could place a lien on your half-built house even if you’ve paid your general contractor in full.
Retainage
Many lenders hold back 5–10% of each draw as retainage, releasing that money only after the entire project is finished and inspected. Retainage gives your builder a financial incentive to close out punch list items rather than walking away from the final details. The accumulated holdback is released at the end.
What You Pay During the Build
During construction, you owe interest only on the amount that’s been drawn so far, not the full loan amount. If your total loan is $400,000 but only $80,000 has been disbursed for the foundation, you’re paying interest on $80,000. As more draws are released, your monthly payment climbs.
Interest rates on construction loans usually run one to two percentage points above conventional mortgages. As of March 2026, the prime rate sits at 6.75%, and most construction loan rates are quoted as prime plus a margin. A lender charging prime plus 1% would put your rate at 7.75% on the drawn balance. At that rate, an $80,000 outstanding balance works out to roughly $517 per month in interest. By the time $300,000 is outstanding, the same rate produces a payment around $1,938. These numbers climb further if the prime rate rises during your build.
The Rate Lock Problem
Your permanent mortgage rate isn’t set until the loan converts, which could be a year or more after you close. If rates jump during that period, your long-term payment could land well above what you budgeted. Some lenders offer a rate lock during construction, protecting your permanent rate for up to 12 months. Better programs include a float-down option: if rates drop while you’re building, you can take the lower rate. Not every lender offers this, and those that do may charge an upfront fee.
Builder’s Risk Insurance
Your lender will require builder’s risk insurance, also called course of construction insurance, before releasing the first draw. A standard homeowners policy doesn’t cover a house under construction. Builder’s risk coverage protects the partially built structure, materials on-site or in transit, and installed equipment against fire, storms, theft, and vandalism. Fannie Mae requires this coverage to equal at least 100% of the home’s completed value.2Fannie Mae. Builders Risk Insurance Some policies also cover soft costs like re-permitting expenses and additional loan interest if a covered event delays the project.
Other Carrying Costs
Interest isn’t the only expense while you build. You’ll also owe property taxes on the land (and eventually on the partially completed structure once the assessor catches up), draw inspection fees charged by the lender, and potentially rent or mortgage payments on wherever you’re living. These add up faster than most people expect, especially if the build runs long. Budget for them separately from your construction costs.
What It Takes to Qualify
Construction loans carry more risk for lenders than traditional mortgages because there’s no finished house to foreclose on if things go wrong. The qualification standards reflect that.
Most conventional construction loans require a credit score of at least 680, and many lenders set the bar higher. Down payments typically start at 20% of the total project cost, though some lenders will accept 15% at closing if you’ll have at least 20% equity once the home is appraised at completion. If you already own the land you’re building on, the equity in that lot often counts toward your down payment, sometimes covering it entirely.
Beyond standard income and asset verification, lenders want a detailed picture of what’s being built and who’s building it:
- A signed fixed-price or guaranteed-maximum-price construction contract with a licensed general contractor, spelling out scope and timeline.
- A line-item budget covering site work, foundation, framing, roofing, mechanical systems, finishes, and every other major cost category. Vague budget lines are a common reason for rejection.
- Full architectural plans and specifications, which the lender’s appraiser uses to estimate the completed property’s value.
- Builder credentials: state license where required, general liability insurance, workers’ compensation coverage, and often a portfolio of past projects.
Because the house doesn’t exist yet, the appraiser’s estimate of its completed value is a critical step. The lender is betting on a future asset, and the appraisal determines how much they’ll lend. If the appraised value comes in low, you’ll need to cover the gap with a larger down payment or scale back the project.
Owner-Builders and Government Programs
If you plan to act as your own general contractor, your options shrink dramatically. Most banks won’t approve an owner-builder construction loan, and FHA and VA programs explicitly prohibit self-builds. A small number of lenders do offer owner-builder financing, but they typically require you to demonstrate construction experience through licensing, education, or completed projects.
If a 20% down payment is out of reach, the FHA one-time close program allows as little as 3.5% down with a minimum 620 credit score, limited to single-family stick-built primary residences. Eligible veterans and service members can use a VA one-time close loan, which may require no down payment at all; borrowers don’t begin making payments until construction is complete.3Department of Veterans Affairs. Circular 26-18-7 – VA One-Time Close Construction Loans Both programs require a licensed general contractor.
When the Budget or Timeline Slips
Construction projects almost never land exactly at the original budget. Materials prices shift, site conditions surprise everyone, and design changes mid-build are nearly inevitable. Most lenders require a contingency reserve of 5–10% of the total project cost built into your loan. That reserve absorbs legitimate cost increases without a loan modification.
If your project blows past the contingency, you generally have three options. You can cover the gap out of pocket. You can ask the lender to increase the loan amount, which requires a new appraisal and fresh underwriting. Or the project pauses while you figure it out, which triggers additional carrying costs, extended interest, and potential contractor disputes. A fixed-price or guaranteed-maximum-price contract is the best defense.
Timelines carry their own limits. Most construction loans give you 12 months to finish the build. For loans Fannie Mae will purchase, no single construction period can exceed 12 months, and the total construction phase including any extension can’t exceed 18 months.4Fannie Mae. Conversion of Construction-to-Permanent Financing: Single-Closing Transactions If construction runs past those limits, the lender must process the loan as a two-closing transaction.
Missing the deadline isn’t just paperwork. Many lenders charge an extension fee, and if enough time passes, you may need to requalify entirely: updated income verification, a fresh credit pull, and a new appraisal. If your credit dropped, rates rose, or the property’s value shifted, you could end up with worse terms or a denial. Weather delays and supply chain problems are common causes, so building realistic slack into the schedule from the start is far cheaper than dealing with an extension.
Converting to a Permanent Mortgage
The construction phase officially ends when the local building authority issues a certificate of occupancy, confirming the home is safe to live in.5Department of Veterans Affairs. Procedures Modification for Processing Proposed and Under Construction Cases What happens next depends on your loan structure.
With a single-close loan, the debt transitions from the interest-only construction phase into a standard amortizing mortgage. The lender verifies the final inspection, confirms the completed home matches the original plans and specifications, and adjusts the payment to include both principal and interest.4Fannie Mae. Conversion of Construction-to-Permanent Financing: Single-Closing Transactions If the home’s value declined or your finances changed significantly during the build, the lender may require requalification. Otherwise you don’t sign new loan documents or pay additional closing costs. Significant changes to the floor plan, square footage, or finishes can trigger a new appraisal; if that appraisal comes in low, you’ll need to bring cash or renegotiate terms.
For a two-close loan, the process is more involved. You pay off the construction lender with proceeds from a brand-new permanent mortgage, which means a second title search, another full appraisal, another credit check, and another round of closing costs. The advantage is flexibility: you can shop multiple lenders for the best permanent rate rather than being locked into terms set when you started the build. The disadvantage is cost and the uncertainty of qualifying again months later.
Both paths end with a final walkthrough to confirm punch list items like paint touch-ups, hardware installation, and flooring adjustments meet the standards in your contract. Once permanent financing is in place, construction oversight ends and the relationship becomes a standard mortgage: principal, interest, property taxes, and insurance, like any other home loan.