Yes, a construction loan is a mortgage. It creates a first-priority lien on your real property and gives the lender the right to foreclose if you stop paying, the same legal structure as the loan used to buy a finished house.1U.S. Securities and Exchange Commission. EX-10.36 Construction Loan and Security Agreement What makes it different is almost everything else: the money comes out in stages instead of a lump sum, you pay interest only during the build, the term runs just 6 to 18 months, and the loan either converts into a standard mortgage at the end or gets paid off by a new one.
How the Money Actually Moves
A traditional purchase mortgage funds once. You sign at closing, the seller gets paid, and you begin making principal-and-interest payments the following month. A construction loan works on a draw schedule instead. Your builder requests a portion of the total loan amount at each major milestone, and the lender releases that portion only after confirming the work is done. Typical milestones include completing the foundation, framing the structure, installing the roof, and finishing the interior.2Fannie Mae. FAQs: Construction-to-Permanent Financing
During the build, you pay interest only on the money that has actually been disbursed. If your loan is approved for $400,000 but only $150,000 has been drawn, interest is calculated on $150,000. That keeps payments manageable while you’re almost certainly also paying rent or another mortgage somewhere else. Most lenders send an inspector before releasing each draw, and those inspections typically cost $150 to $400 per visit.
Rates reflect the added risk of lending against a structure that doesn’t exist yet. Construction loan rates generally run between 6% and 8%, often slightly above prevailing 30-year fixed mortgage rates. Half-built houses are poor collateral, and lenders price accordingly.
One Mortgage or Two: The Closing Structure Decides
Whether your construction loan is ultimately one mortgage or two depends on which structure you choose at the start.
Construction-to-Permanent (One Close)
A one-close loan covers both phases under a single set of loan documents. You close once, the lender funds draws during construction, and when the home is complete the loan converts into a standard amortizing mortgage. Your permanent interest rate is locked at the initial closing.3Fannie Mae. Conversion of Construction-to-Permanent Financing: Single-Closing Transactions The conversion itself happens through a modification agreement that shifts the loan from interest-only draws to monthly principal-and-interest payments.
You pay one set of closing costs and go through title work once. The trade-off is that your long-term rate is set before the first shovel hits dirt, which can cut either way depending on where rates move during the build.
Standalone Construction (Two Close)
A two-close structure uses two separate loans. The first covers construction. When the house is finished, you close on a brand-new permanent mortgage that pays off the construction loan. Fannie Mae treats the permanent loan as a refinance of the construction debt, not a modification.4Fannie Mae. Two-Closing Construction to Permanent Financing
The flexibility is real. You can shop for your permanent lender separately and lock the long-term rate closer to move-in. The cost is paying closing costs twice. Standard closing costs run 2% to 5% of the loan amount,5Fannie Mae. Closing Costs Calculator and doubling that up adds thousands to the project. The construction lien must be fully satisfied before the permanent mortgage takes its place as the primary security interest.
Qualifying Is Harder Than for a Standard Mortgage
Because the lender is betting on a building that doesn’t exist yet, the qualification bar sits higher than for a purchase mortgage.
Conventional construction loans typically require 5% to 20% down, with the exact figure depending on your credit score, loan-to-value ratio, and the lender’s internal guidelines. Minimum credit scores run higher than lenders accept for a standard purchase mortgage. If you put down less than 20%, expect private mortgage insurance once the loan converts to permanent financing.
FHA-backed construction loans open a lower door. The minimum down payment is 3.5% of the appraised value or total project cost (whichever is lower) if your credit score is at least 580. Scores between 500 and 579 require at least 10% down.6HUD.gov. FHA Single Family Housing Policy Handbook VA-backed construction loans allow eligible veterans and service members to build with no down payment.7VA.gov. Eligibility For VA Home Loan Programs
Your builder gets vetted too. Lenders require proof of state licensing, general liability insurance, and workers’ compensation coverage. FHA loans require an FHA-approved builder. The VA recently eliminated its separate builder identification number requirement for most VA-guaranteed loans, though builders still have to meet state and local licensing.8Veterans Benefits Administration. Elimination of Builder Identification Number for Certain Guaranteed Loans and Updates to Builder Complaint Process
Planning to act as your own general contractor? Most lenders will end that conversation quickly. Owner-builder construction loans are rare, and the few lenders offering them typically require the borrower to hold a current contractor’s license.
How It Becomes a Regular Mortgage
The transition starts when your local building department issues a Certificate of Occupancy, confirming the structure meets applicable safety codes. The lender then sends an inspector to verify the completed home matches the original plans.
In a one-close loan, you sign a modification agreement that officially converts the loan into its amortizing phase with monthly principal-and-interest payments.3Fannie Mae. Conversion of Construction-to-Permanent Financing: Single-Closing Transactions In a two-close arrangement, you attend a second closing to sign a new mortgage note and deed of trust. Either way, the title company runs a final search to confirm no mechanic’s liens were filed against your property during construction.
The mechanic’s lien check matters more than most borrowers realize. In many states, a subcontractor or materials supplier who wasn’t paid by your builder can file a lien against your property. Some states allow these liens to relate back to the date construction began, meaning a lien filed at the end of the project can take priority over a deed of trust recorded months earlier. That’s why lenders require lien waivers from all contractors before releasing the final draw and authorizing the conversion.
Once disbursements are complete and title is clear, the interim construction lien is satisfied and the permanent mortgage is recorded with the county. Your homeowner’s insurance has to be updated to cover the completed structure under the new loan terms.
Mortgage Interest Deduction Rules Are Different Too
Interest you pay during construction can be deductible, but with sharper edges than the deduction on a regular mortgage.
The IRS lets you treat a home under construction as a qualified home for up to 24 months, starting any time on or after the day construction begins. If the home becomes your primary or secondary residence once ready for occupancy, the mortgage interest paid during that 24-month window can qualify as deductible home acquisition debt.9Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction
The catch most people miss: interest on a loan for bare land you own and intend to build on is not deductible as mortgage interest. The deduction window opens when construction actually begins, not when you buy the lot.10Internal Revenue Service. Real Estate Taxes, Mortgage Interest, Points, Other Property Expenses If you buy land in January and don’t break ground until September, those eight months of interest on the land loan generally aren’t deductible as mortgage interest. The 24-month ceiling also means a project that stretches beyond two years from the start of construction can lose deductibility for interest paid outside that window.
Risks That a Standard Mortgage Doesn’t Carry
A purchase mortgage attaches to a finished house. A construction loan attaches to a work in progress, and that gap introduces risks you won’t see on a conventional loan.
If your builder goes bankrupt, abandons the project, or fails to perform, you’re left holding a loan against a partially built house. Contact your lender immediately to freeze any remaining disbursements. Finding a replacement contractor to finish someone else’s half-built project is expensive, and the new builder often has to redo portions of the existing work to meet their own standards. A partially completed home is worth far less than the money already poured into it. If you default at this stage, the lender’s collateral may sell at a steep discount, and you may still owe the difference.
Cost overruns are the other common pressure point. Most projects set aside 5% to 10% of the total budget as a contingency reserve for scope changes and material price increases, and some lenders require the reserve be built into the loan. If you blow through the contingency, you cover the gap out of pocket or negotiate additional financing mid-build, neither of which is simple.
Finally, if you chose a two-close structure, your permanent mortgage rate isn’t locked until construction nears completion. If rates climb significantly across a 12- to 18-month build, the monthly payment on your permanent loan can run well above what you projected at groundbreaking. One-close loans avoid that exposure but also remove the chance to benefit if rates fall.