To finance a new construction home, you take out a construction loan that funds the build in stages and then either converts to or is replaced by a long-term mortgage once the house is finished. It works nothing like buying an existing home: there’s no finished collateral on day one, the lender pays the builder in installments after inspections, and you pay interest only on what’s been drawn so far. Down payments run from 3.5% on government-backed programs to 20% or more on conventional construction loans, and interest rates sit above standard mortgage rates because the lender is carrying completion risk the whole way through.
One Loan or Two
Your first decision is the loan structure. A construction-to-permanent loan, also called a single-close or one-time-close loan, bundles the building phase and the long-term mortgage into one transaction.1Fannie Mae. B5-3.1-02, Conversion of Construction-to-Permanent Financing: Single-Closing Transactions You close once. You pay interest only during construction. When the home is done, the loan automatically converts to a standard 15- or 30-year mortgage with principal-and-interest payments. One approval, one set of closing costs, and the permanent rate is locked before the first shovel hits dirt. The construction phase on a single-close loan cannot exceed 18 months.2Fannie Mae. FAQs: Construction-to-Permanent Financing
A stand-alone construction loan is a short-term note, usually 12 to 18 months, that covers only the build. When the home is finished, you pay it off by closing on a separate permanent mortgage. Two applications, two sets of closing costs, two qualification rounds. The flexibility is real: if rates drop while you’re building, you can shop for the permanent loan. So is the exposure: if rates have climbed by the time the build wraps up, you take the market as you find it.
Interest Rates and Rate Locks
Construction loan rates typically run a few percentage points above standard mortgage rates. The exact premium depends on the lender, your profile, and project complexity, but expect to pay more because the lender is lending against something that doesn’t exist yet.
Rate locks are where the math catches people off guard. A regular mortgage lock lasts 30 to 45 days. A construction loan needs 90, 120, or 180 days, because the permanent rate has to survive the build. Longer locks cost more upfront, often 0.75% to 1% of the loan amount. On a $400,000 loan, that’s $3,000 to $4,000 just to hold the rate. If the builder runs behind and the lock expires, extensions are usually sold in 15-day increments at 0.125% to 0.25% of the loan each. Three extensions on a $400,000 loan can add $1,500 to $3,000 in fees. Build a realistic timeline buffer into the lock period before you commit.
Low- and No-Down-Payment Options
Not every construction loan demands 20% down and a 700-plus credit score. Government-backed programs open new construction to borrowers who wouldn’t clear conventional underwriting.
FHA One-Time Close
FHA one-time close construction loans require as little as 3.5% down.2Fannie Mae. FAQs: Construction-to-Permanent Financing FHA credit score minimums start around 620, though individual lenders often set overlays in the mid-600s. The trade-offs: mortgage insurance premiums for the life of the loan (unless you later refinance into a conventional mortgage), and the property must be a one-unit primary residence. Investment properties and second homes are out. Stick-built homes, modular homes, and new manufactured housing on a permanent foundation all qualify.
VA Construction Loans
Eligible veterans and active-duty service members can use VA home loan benefits for new construction, potentially with no down payment at all.3U.S. Department of Veterans Affairs. Eligibility For VA Home Loan Programs VA construction loans are harder to find because fewer lenders offer them, and the process includes VA-specific inspections. Service requirements vary by era: generally 90 continuous days of active duty during wartime or 181 days during peacetime.
What Lenders Want From You
Construction loans have tighter qualification standards than standard mortgages because the lender is taking on more risk. Expect the following across most programs:
- Credit score: conventional construction lenders generally want 680 minimum, and 720 or higher for custom builds with complex budgets. FHA accepts 620.
- Debt-to-income ratio: total monthly debt payments, including the projected mortgage, usually need to stay below 43% to 45% of gross monthly income.
- Down payment: 5% to 20% on conventional loans, with 20% needed to avoid private mortgage insurance. FHA starts at 3.5%, VA at zero.
- Cash reserves: enough liquid savings to cover the down payment plus several months of interest-only payments. Delays happen, and lenders want evidence you won’t run out of cash if the build slips.
On documentation, expect the standard package: two years of W-2s, two years of federal tax returns, recent bank statements. Self-employed borrowers should prepare profit-and-loss statements and business tax returns. The lender will verify the source of your down payment, so document any large deposits or gift funds well before you apply.
What Lenders Want From the Project
Your finances are only half the file. The lender is also underwriting the project, and this is where construction loans leave standard mortgages behind.
You’ll provide detailed architectural blueprints and a line-item cost breakdown that separates hard costs from soft costs. Hard costs are the physical construction expenses: labor, materials, subcontractors for electrical, plumbing, and HVAC, plus fixtures and appliances. Soft costs are the professional and administrative side: architectural and engineering fees, building permits, surveys, legal fees, financing costs. Lenders scrutinize both because they need to verify the budget is realistic for what’s being built.
A signed construction contract spelling out scope, payment schedule, and completion timeline is required. The builder gets vetted too: valid contractor’s license, proof of general liability insurance, and often a track record of completed projects. The lender is effectively betting on this builder’s ability to finish on time and on budget, so builder qualifications matter. If your builder can’t produce clean documentation, find a different builder before you apply.
You’ll complete a Uniform Residential Loan Application (Fannie Mae Form 1003), the same form used for standard mortgages but with construction-specific fields for land acquisition cost and total projected construction price.4Fannie Mae. Uniform Residential Loan Application Have your builder’s cost estimates in hand before you start filling it out.5Fannie Mae. Instructions for Completing the Uniform Residential Loan Application
Acting as Your Own Contractor
If you plan to be your own general contractor, most lenders won’t touch the loan. Owner-builder construction loans exist but are rare, and lenders typically require the borrower to hold a contractor’s license. A handful of lenders offer owner-builder programs, with higher down payments, more documentation, and frequent progress updates.
The Subject-to-Completion Appraisal
Because the home doesn’t exist yet, the lender orders a “subject-to-completion” appraisal. The appraiser reviews your blueprints and cost breakdown, then compares the planned home against similar recently sold properties to estimate what it will be worth once built.6Fannie Mae. Requirements for Verifying Completion and Postponed Improvements That projected value sets your loan-to-value ratio and caps how much the lender will advance.
If the appraised future value comes in low, the lender won’t stretch the loan to match the budget. You bring more cash, reduce scope, or challenge the appraisal. This happens more often than people expect in areas without many comparable new-construction sales.
The appraisal must be completed within 12 months before the note date. If more than four months pass between appraisal and closing on the permanent loan, the lender must obtain an appraisal update confirming the property hasn’t declined in value. If the update shows a decline, a full new appraisal is required.7Fannie Mae. Appraisal Age and Use Requirements Single-close construction-to-permanent loans are exempt from these age requirements.
Builder’s Risk Insurance
A half-built house can’t be covered by a standard homeowner’s policy because it isn’t a finished home. Builder’s risk insurance, sometimes called course-of-construction insurance, fills the gap, covering the structure and materials on site against fire, storms, theft, and vandalism during the build.
Either the builder or the homeowner can carry it, but the lender will require proof it’s in place before releasing any funds. Make sure the policy covers full replacement cost of the structure at completion, not just the amount spent to date. The lender will also require your builder to carry general liability insurance, typically at least $1 million per occurrence, for injuries or property damage on the job site. Confirm both policies before construction starts, and make sure the lender is named as an additional insured on the builder’s risk policy.
How the Money Gets to the Builder
Construction loans don’t release the full amount at closing. Money comes out in stages called draws. A typical residential loan uses around five draw stages, each releasing roughly 20% of the total:
- Stage 1: site clearing, underground plumbing, and foundation pour.
- Stage 2: framing, roofing, and window installation.
- Stage 3: plumbing, electrical, and HVAC rough-ins, plus exterior siding and insulation.
- Stage 4: interior work — cabinets, countertops, flooring, and gutters.
- Stage 5: finish trim, painting, appliances, final inspection, and occupancy.
When the builder finishes a stage, they submit a draw request. The lender sends an inspector to verify the work matches the claim. If the milestone checks out, the funds release. If the work is incomplete, the draw is held until the issue is resolved. You pay interest only on the cumulative amount drawn, so monthly payments grow as the build progresses.
Retainage
Most construction loans include a retainage provision: the lender withholds 5% to 10% of each draw until final completion. Retainage gives the builder a financial incentive to finish the job and address punch-list items. The retained funds release after the final inspection confirms the home is complete and matches the approved plans.
Planning for Cost Overruns
Construction budgets face pressure constantly: material price spikes, design changes, unforeseen site conditions, subcontractor delays. Lenders require a contingency reserve built into the budget, usually 5% to 10% of total construction cost for straightforward projects, and up to 15% to 20% for complex or high-risk builds.8FHA Connection. Standard 203(k) Contingency Reserve Requirements
If costs blow through both the original budget and the contingency, you generally pay the difference out of pocket or negotiate a scope reduction with the builder. The lender won’t simply increase the loan amount without new appraisal and underwriting review. A $350,000 build with zero contingency is a $350,000 problem waiting to happen.
Risks Worth Protecting Against
Mechanic’s Liens
Even if you’ve paid your general contractor every penny on time, a subcontractor or material supplier who didn’t get paid by the contractor can file a mechanic’s lien against your property. You could end up paying twice for the same work, once to the contractor and once to clear the lien, or face foreclosure if the lien goes unresolved. Laws vary by state, but the risk exists everywhere.
The fix is lien waivers. Ask your builder for signed waivers from every subcontractor and supplier as each draw is completed, confirming each one has been paid for the work in that stage. Some lenders require them before releasing funds. If yours doesn’t, request them yourself.
Builder Default
If your builder goes bankrupt, abandons the project, or is fired for cause, you’re left with a partially built home and an active construction loan. The lender still expects interest payments, and finding a replacement builder willing to pick up someone else’s half-finished work typically costs more than starting fresh. Some contracts include performance bonds or completion guarantees that provide financial protection if the builder fails to deliver. They cost extra, but on a large custom build they’re worth asking about. At minimum, verify adequate insurance and a documented history of completed projects before signing anything.
Finishing the Build and Converting to a Permanent Mortgage
The construction phase ends when your local building department issues a Certificate of Occupancy, confirming the home meets safety and building codes. The lender then orders a final completion report, Fannie Mae Form 1004D, where the appraiser or an approved alternative verifies the home matches the original plans.6Fannie Mae. Requirements for Verifying Completion and Postponed Improvements This can be a physical site visit, a virtual inspection, or an attestation letter with supporting photos, depending on the lender.
With a single-close loan, conversion is automatic. The construction loan terms flip to the permanent mortgage terms set at the original closing, and your payments shift from interest-only to principal and interest.1Fannie Mae. B5-3.1-02, Conversion of Construction-to-Permanent Financing: Single-Closing Transactions If the property value has declined since the original appraisal or other loan conditions have changed, the lender may need to requalify you before conversion.
With a two-close loan, you go through a full second closing: new application, new underwriting, new closing costs, new lien recorded against the property. The permanent mortgage pays off the construction balance, and standard monthly payments begin. Budget for the second round of closing costs from the start.
Any funds left in the construction escrow after completion are typically applied as a principal reduction on the permanent mortgage.9eCFR. Subpart C Loan Requirements After conversion, the house is treated like any other property with a standard long-term mortgage.