To build a house with borrowed money, most people use construction loans, a specialized form of financing that releases funds in stages as the home goes up and, in many cases, converts into a permanent mortgage once it’s finished. Qualifying is harder than buying an existing house because the collateral doesn’t exist yet. Plan on a credit score around 680 or higher, a down payment of at least 20% for a conventional loan, and a thick file of documentation covering your finances, your builder, and the project itself.
Single-Close vs. Two-Close Construction Loans
Conventional construction financing comes in two structures, and the choice shapes your closing costs, your rate risk, and your flexibility.
A construction-to-permanent loan, also called single-close, wraps the building phase and the long-term mortgage into one transaction.1Fannie Mae. Single-Closing Construction-to-Permanent Lender Fact Sheet You close once, pay one set of closing costs, and lock in the permanent interest rate before construction begins. During the build, you make interest-only payments on whatever has actually been drawn, so early payments are small and grow as the loan is disbursed. When the final inspection clears, the loan converts automatically into a standard fixed- or adjustable-rate mortgage.
The tradeoff is rate flexibility. If market rates fall during a twelve-month build, you’re stuck at the rate you locked unless you refinance after conversion, which triggers another round of closing costs. Most single-close loans allow up to twelve months of construction, and if you run behind, some lenders will grant a one-time extension of roughly three months for a fee that can run around 0.50% of the loan balance.
A stand-alone construction loan, or two-close loan, splits the financing into two separate transactions. The construction loan runs about twelve months. When the house is done, you close on a completely separate permanent mortgage that pays off the construction loan. You get to shop rates when construction ends, and you can use proceeds from selling your current home to shrink the permanent loan balance.
The downside is that two closings means two sets of closing costs, two title insurance premiums, and two full underwriting reviews. The second underwriting includes a fresh credit check, so a job loss, a new debt, or a credit hit during construction can leave you unable to qualify for the permanent loan. To offset that risk, lenders often require 20% to 25% down on two-close loans. For most borrowers with stable finances, the single-close structure is simpler and cheaper.
Government-Backed Construction Loans
If you can’t put 20% down or your credit isn’t in conventional territory, three federal programs offer construction financing with easier terms.
FHA One-Time Close
The Federal Housing Administration backs a one-time close construction-to-permanent loan with a minimum credit score of 580 and a down payment of just 3.5%. In exchange, you pay an upfront mortgage insurance premium of 1.75% of the base loan amount at closing, plus an annual premium of roughly 0.55% that gets added to your monthly payment for the life of the loan in most cases.2U.S. Department of Housing and Urban Development. Mortgage Insurance Premiums The loan covers land, construction, and permanent financing in a single closing and must be used for a primary residence.
A quick boundary: the FHA 203(k) loan is a separate product for buying and renovating an existing home at least a year old, not for building new from the ground up.3U.S. Department of Housing and Urban Development. 203(k) Rehabilitation Mortgage Insurance Program For new construction, the FHA One-Time Close is the correct program.
VA Construction Loans
Active-duty service members, veterans, and eligible surviving spouses can build with no down payment and no private mortgage insurance.4VA News. VA Offers Construction Loans for Veterans to Build Their Dream Homes The VA guarantees a portion of the loan rather than lending directly, and private lenders originate the financing.5Veterans Benefits Administration. VA Home Loans
A funding fee is rolled into the loan. For first-time users with nothing down, it’s 2.15% of the loan amount. At 5% down it drops to 1.50%, and at 10% or more it falls to 1.25%. Veterans with a service-connected disability are typically exempt. Not every VA-approved lender handles construction financing, so the participating pool is smaller than for standard VA purchase loans and can take some searching.
USDA Construction Loans
The USDA Single Family Housing Guaranteed Loan Program offers 100% financing to build in designated rural areas, with no down payment required. Household income generally cannot exceed 115% of the area’s median family income,6Rural Development. Guaranteed Housing Program Income Limits and the property must sit in a USDA-eligible area and serve as your primary residence.7United States Department of Agriculture, Rural Development. Welcome to the USDA Income and Property Eligibility Site
USDA construction loans are single-close, with one 30-year set of loan documents covering both phases, and the rate is set at closing.8USDA Rural Development. Single Family Housing Guaranteed Loan Program Combination Construction to Permanent Loans The program builds in an interest reserve that covers your payments during construction, so you don’t juggle loan payments alongside rent. Inspection schedules are stricter than conventional financing, and the home must meet USDA property and energy-efficiency standards.
What Lenders Require to Qualify
Construction underwriting is more demanding than a standard purchase mortgage because the lender is betting on a house that doesn’t exist yet. The application has two halves: you, and the project.
Your Financial Profile
Lenders verify income and assets with tax returns, W-2s, pay stubs, and bank statements from the past two years. Federal rules require the lender to make a reasonable determination of your ability to repay using third-party records.9Consumer Financial Protection Bureau. 12 CFR Part 1026 – Regulation Z Most construction lenders want a credit score of at least 680, though the government programs accept lower. Scores above 720 unlock better rates and lower fees.
Debt-to-income ratio matters heavily. The Qualified Mortgage framework generally caps total DTI at 43%, meaning your projected housing payment plus all other monthly debts shouldn’t exceed 43% of gross monthly income.10Board of Governors of the Federal Reserve System. The Effects of the Ability-to-Repay / Qualified Mortgage Rule on Mortgage Lending Some lenders exceed that for strong borrowers with cash reserves, but rate premiums climb quickly.
For a conventional construction loan, expect to put at least 20% down on total project cost (land plus construction). If you already own the lot free and clear, the equity in that land often counts toward the down payment, which is one of the biggest reasons to buy your lot early. You’ll need to submit the deed or purchase contract for the land with your application.
Builder and Project Documentation
The lender underwrites your builder almost as thoroughly as it underwrites you. Plan to submit the builder’s professional license, general liability insurance, and workers’ compensation coverage, along with evidence of financial capacity and track record.
The project package needs professionally drawn blueprints, a line-item construction budget covering every expense from excavation to landscaping, and a timeline with milestone dates. You’ll also need a description of materials document that specifies the quality of finishes throughout the house: flooring, appliances, cabinets, windows, and similar details.11U.S. Department of Housing and Urban Development. Description of Materials These figures set the loan-to-cost ratio and cap the maximum the lender will advance.
The signed construction contract between you and the builder establishes the disbursement schedule, states the total price, and defines when payments are triggered. Lenders require it fully executed before any funds move.
How Draws Work After Closing
Loan money doesn’t land in your account at closing. The lender releases it in stages tied to construction milestones, and this is where construction financing feels most different from a regular mortgage.
Before the first draw, the lender orders an as-completed appraisal. An independent appraiser reviews your plans, specifications, and budget, then compares them to recently built comparable homes to estimate what the finished property will be worth. Land value, projected home value, and improvements like driveways or wells all factor in.
A typical draw schedule has five or six disbursements tied to milestones like these:
- Foundation completion: excavation, footings, and slab or basement walls poured and cured
- Framing: structural skeleton standing, sheathed, and roofed
- Mechanical rough-in: plumbing, electrical, and HVAC in the walls
- Interior finishes: drywall, flooring, cabinets, and fixtures installed
- Final completion: municipal inspection passed and certificate of occupancy issued
Before each draw is released, a third-party inspector visits the site to confirm the work described in the draw request is actually complete. At each stage, the lender also collects lien waivers from the builder and subcontractors, which are signed statements confirming they’ve been paid for completed work and won’t file a claim against the property. A draw request will sit until the waivers are in.
Interest-only payments during construction are calculated on the cumulative amount drawn, not the full loan balance. Multiply the total disbursed so far by your rate, divide by twelve, and you have a rough monthly figure. Payments start small and grow as the house goes up.
Insurance During the Build
A standard homeowners policy won’t cover a house under construction; it’s built for occupied, finished homes and typically voids coverage after 30 to 60 days of vacancy. Construction lenders require a builder’s risk policy, sometimes called course-of-construction insurance, that covers the specific hazards of an active job site.
Builder’s risk covers damage to the structure and building materials from fire, wind, vandalism, and theft. It also covers uninstalled materials on site, materials in transit, and soft costs like extra loan interest or architectural fees if a covered loss delays the project. The policy runs for a fixed term matching your construction schedule, usually six to twelve months. Premiums typically fall between 1% and 4% of total construction costs.
Builder’s risk doesn’t cover liability. Injuries on the site fall under your builder’s general liability policy and workers’ compensation coverage, both of which lenders require proof of before releasing funds. For general liability, $300,000 per incident is a common floor. Workers’ compensation rules vary by state, but if an uninsured worker is hurt on your property, you can face personal liability.
Contingency Reserves for Cost Overruns
Construction projects almost always cost more than the initial estimate, and lenders build a contingency reserve into the loan to absorb it. The reserve is cash earmarked for unexpected expenses: material price increases, unforeseen site conditions, mid-build design changes.
The standard requirement is 10% of construction costs for smaller projects. On larger builds, often above $400,000, some lenders require 15%. You can usually finance the contingency into the loan if the appraised value supports it, or fund it with cash. Unused funds either reduce your loan balance at conversion or come back to you if you paid cash.
The hard case is when overruns exceed the contingency. At that point, you’re paying out of pocket or renegotiating scope with the builder. Lenders generally won’t increase the loan amount after closing unless the appraisal supports it and you go through additional underwriting. An accurate, detailed budget at application matters more than almost anything else. Underestimating costs to squeeze into a loan is one of the fastest ways to end up stuck mid-build.
Being Your Own General Contractor
Owner-builder loans let you manage the construction yourself instead of hiring a general contractor, saving the 10% to 20% markup a GC typically charges. The financing is significantly harder to obtain, though. Many mainstream lenders won’t offer these loans at all, and those that do often limit them to licensed contractors or borrowers with demonstrated construction experience. Expect a larger down payment (often 20% or more), a detailed project plan proving you can manage subcontractors and inspections, higher rates, and less tolerance for schedule slippage. The GC savings can be real, but they disappear quickly if the build drags and you’re paying extra months of interest-only payments while stepping away from your regular income.
Tax Treatment of Construction Interest
The IRS lets you treat a home under construction as a qualified home for up to 24 months, starting on or after the day construction begins. Interest paid on your construction loan during that window may be deductible as home mortgage interest, but only if the home actually becomes your primary or secondary residence when it’s ready to occupy.12Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction
The deduction is subject to the overall acquisition-debt limit: for mortgages taken out after December 15, 2017, interest is deductible on up to $750,000 of home acquisition debt, or $375,000 if married filing separately.12Internal Revenue Service. Publication 936 (2025), Home Mortgage Interest Deduction The loan must be secured by the property, and you’ll need to itemize on Schedule A. Builds that stretch past 24 months can lose the deduction on interest paid after the window closes, so keep detailed records of your construction start date and every interest payment from day one. Property taxes on the land and partially completed structure are billed during the build and are generally deductible up to the $10,000 SALT cap ($5,000 if married filing separately) along with your other state and local taxes.