What is a construction loan and how does it work?

A construction loan is a short-term, interim financing solution used to fund the building of a home or real estate project. Unlike traditional mortgages where you receive a lump sum, construction loans disburse funds in stages (called draws) as the building progresses. During the construction phase, you typically pay interest-only on the amount drawn. Once construction is complete, the loan converts to a permanent mortgage or must be refinanced.

How is interest calculated during the construction phase?

During construction, you pay interest only on the funds that have been disbursed, not the full loan amount. As draws are released at different construction milestones, your interest payment increases. Most construction loans use a variable interest rate tied to the prime rate plus a margin. The interest accrued during construction is typically rolled into your permanent mortgage balance.

What is a construction-to-permanent loan?

A construction-to-permanent loan (also called a one-time close loan) combines construction financing and permanent mortgage into a single loan product. This means you only go through one closing process, saving time and money on closing costs. When construction is complete, the loan automatically converts to a traditional mortgage without requiring a new application or additional closing fees.

How much down payment do I need for a construction loan?

Construction loans typically require larger down payments than traditional mortgages. Most lenders require 20-25% down, though some programs may accept as low as 10% for qualified borrowers. The down payment can include the equity in your land if you already own the building site. A larger down payment can help you secure better interest rates and terms.

What are construction loan draw schedules?

A draw schedule outlines when and how construction loan funds are released. Common milestones include: foundation completion, framing, rough mechanicals (plumbing, electrical, HVAC), drywall installation, and final completion. Before each draw, the lender typically requires an inspection to verify the work has been completed. This protects both the borrower and lender by ensuring funds are used appropriately.

Can I act as my own general contractor?

Some lenders allow owner-builder construction loans where you act as your own general contractor, but these are harder to qualify for. You'll need to demonstrate construction experience, project management skills, and have a detailed plan. Owner-builder loans often require larger down payments (25-30%) and may have higher interest rates due to increased lender risk.

Construction Loan Calculator & Cost Estimator

Calculate construction loan payments, estimate building costs, and plan your new home construction financing. Free online tool for construction-to-permanent loans, custom home building, and residential development projects.

Free & Accurate

No Registration Required

Instant Results

Project Details

Construction Cost$350,000

Building and construction expenses only

Land/Lot Cost$100,000

Enter 0 if you already own the land

Down Payment$90,000 (0.0%)

Typically 20-25% for construction loans

Interest Rate (Annual)7.5%

Construction rates typically 1-2% higher than mortgages

Construction Period12 months

Typical custom home: 6-12 months

Permanent Loan Term30 years

Mortgage term after construction completes

Financing Summary

Total Project Cost

Construction Loan Amount

Construction Phase Interest

Interest-only during construction

Monthly Payment (After Construction)

Principal & interest for 30 years

Educational Information Only

This calculator provides educational estimates about construction loan calculations. The information presented on this page is for informational and educational purposes only and does not constitute financial advice, recommendations, or suggestions about what actions you should take.

Actual loan terms, costs, and requirements vary based on individual circumstances, lender policies, market conditions, and many other factors. This tool describes how construction loans work and what factors exist in the lending process, but does not provide guidance on whether any particular loan product or financial decision is appropriate for any specific situation.

Construction Loan Draw Schedule & Timeline

Construction draw schedules outline when and how lenders release funds during the building process. Most lenders release funds in stages as construction milestones are completed and inspected.

Land Acquisition

Purchase the building site and prepare for development

10-25% of total

Site Preparation

Clearing, grading, utility connections, foundation

5-15% of build cost

Foundation & Framing

Pour foundation, construct frame and roof structure

30-40% of build cost

Rough Mechanicals

Install plumbing, electrical, HVAC systems

15-20% of build cost

Finishing Work

Drywall, flooring, cabinetry, fixtures, painting

25-35% of build cost

Final Inspection

Certificate of occupancy and loan conversion

Final draw release

Complete Guide to Construction Loans and Home Building Financing

What Is a Construction Loan?

A construction loan is a short-term financing solution specifically designed to fund the building of a new home, residential property, or major renovation project. Unlike traditional mortgage loans where you receive the full amount upfront, construction financing works differently. The lender disburses money in scheduled payments (called "draws" or "disbursements") as construction progresses through various stages.

During the construction phase, borrowers typically make interest-only payments on the amount that has been drawn down. This means you only pay interest on the funds actually disbursed, not the entire loan amount. Once the home is complete and you receive the certificate of occupancy, the loan either converts to a permanent mortgage (in a construction-to-permanent loan) or must be paid off through refinancing or sale.

Construction loans are considered higher risk than traditional mortgages because they fund a property that doesn't yet exist. As a result, they typically have stricter qualification requirements, higher interest rates, and require larger down payments—usually 20-25% of the total project cost. However, they provide essential financing for custom home builds, new construction developments, and substantial home improvement projects that can't be funded through conventional mortgage products.

Types of Construction Loans: Finding the Right Financing Option

Construction-to-Permanent Loans (One-Time Close)

Also called single-close construction loans or one-time close mortgages, this type combines construction financing and permanent mortgage into one loan product. Borrowers go through one application process and one closing. When construction is complete, the loan automatically converts to a standard mortgage without requiring a new application, credit check, or appraisal.

Characteristics: Single closing involves one set of closing costs, interest rates are locked at the initial closing, the process involves less paperwork compared to two separate loans. This option is commonly used by borrowers building their primary residence who plan to live in the home long-term.

Construction-Only Loans (Two-Time Close)

A construction-only loan (also called a stand-alone construction loan) covers just the building phase. At the end of construction, borrowers either refinance into a permanent mortgage or pay off the loan in full. This involves two separate closings—one for the construction loan and another for the permanent mortgage.

Characteristics: Borrowers can shop for permanent mortgage rates after construction completes, this structure is used by borrowers planning to sell immediately after completion or those expecting financial situations to change. This approach involves two sets of closing costs, exposure to interest rate changes during construction, and a more complex process with two separate applications.

Renovation Construction Loans (FHA 203(k) and HomeStyle Renovation)

These specialized loans allow you to purchase a home and finance renovation costs in a single mortgage. The FHA 203(k) loanis government-backed and allows down payments as low as 3.5%, while the Fannie Mae HomeStyle Renovation loan offers conventional financing with more flexibility on property types.

These loans are commonly used by buyers purchasing fixer-uppers or homeowners planning major remodels including structural changes, room additions, or complete renovations. These programs allow borrowing based on the after-renovation value (ARV) of the property.

Owner-Builder Construction Loans

Borrowers who act as their own general contractor and manage the construction process use anowner-builder loan. These are more difficult to obtain because lenders view them as higher risk. Lenders typically require construction experience, a detailed project plan, and a larger down payment (25-30%). Owner-builder scenarios can involve different cost structures compared to using a professional general contractor, as the borrower directly manages and coordinates subcontractors.

How Construction Loan Interest Works: Draw Schedule and Interest Calculations

Construction loan interest operates differently than traditional mortgage interest. Unlike mortgages where borrowers pay interest on the full loan amount from day one, construction loan interest is calculated only on disbursed funds. Here's how it works:

Construction Draw Schedule Example

•Month 1: $50,000 drawn for foundation - you pay interest only on $50,000
•Month 2: Additional $75,000 drawn for framing - you pay interest on $125,000 total
•Month 3: Additional $60,000 drawn for mechanicals - you pay interest on $185,000 total

Most construction loans use a variable interest rate tied to the prime rate plus a margin (typically 1-3%). This means your rate can fluctuate during construction, though some lenders offer rate locks. The average construction loan interest rate in 2024-2025 ranges from 7% to 10%, typically 1-2 percentage points higher than traditional mortgage rates due to increased lender risk.

At the end of construction, all accrued interest is typically rolled into the permanent mortgage balance. This is why the calculator shows both construction phase interest and the final monthly payment after conversion, illustrating the complete cost structure of construction-to-permanent financing.

Construction Loan Requirements: Qualifying for Home Building Financing

Construction loan approval requirements are more stringent than traditional mortgages. Lenders scrutinize every aspect of your financial situation and construction plan because they're funding a property that doesn't yet exist. Here's what you'll need:

Credit Score Requirements

Most lenders require a minimum credit score of 680 for construction loans, with many preferring 700+. A higher credit score (740+) qualifies borrowers for better interest rates and may reduce down payment requirements. FHA construction programs exist with minimum credit scores as low as 620, though qualification standards vary by lender and program.

Down Payment and Equity Requirements

Expect to put down 20-25% of the total project cost for most construction loans. If you already own the land, your equity in the lot can count toward this requirement. For example, if you own land worth $100,000 and your construction costs are $350,000 (total project $450,000), your land equity covers 22% of the project cost. Some lenders may accept lower down payments (10-15%) for extremely qualified borrowers or specific loan programs.

Debt-to-Income Ratio (DTI)

Your debt-to-income ratio should be below 43%, with many lenders preferring 36% or lower. This includes your future housing payment plus all other monthly debt obligations. Lenders calculate DTI using your projected permanent mortgage payment, not the construction phase interest-only payment.

Cash Reserves

Lenders typically require cash reserves equal to 2-6 months of mortgage payments after closing. Reserve requirements provide a financial buffer if construction runs over budget or timeline. Construction budgets commonly include contingency funds of 10-20% for unexpected costs, as cost overruns occur in many custom builds.

Detailed Construction Documentation

You'll need comprehensive documentation including: complete architectural plans (blueprints), itemized construction budget (line-by-line cost breakdown), construction timeline (Gantt chart or schedule), builder's license and insurance, builder's resume and references, signed construction contract, land appraisal or purchase agreement, soil tests and surveys, and building permits or permit applications.

Construction Costs and Budgeting: What to Expect When Building a Home

Construction costs vary widely based on multiple factors. As of 2024-2025, the average cost to build a custom home in the United States ranges from $150 to $400+ per square foot, depending on location, finishes, and complexity.

Average Construction Cost Breakdown

Site Work & Foundation:10-15%

Framing & Structural:15-20%

Exterior Finishes:10-15%

Major Systems (HVAC, Plumbing, Electrical):15-20%

Interior Finishes:20-25%

Cabinets & Countertops:8-12%

General Contractor Fee:10-20%

Permits & Fees:1-3%

Regional variations significantly impact costs. Building in high-cost areas like California, New York, or Hawaii can cost $300-500+ per square foot, while Midwest and Southern states may average $150-250 per square foot. Urban locations with strict building codes, limited builder availability, and higher labor costs will always be more expensive than rural areas.

Many construction budgets include a contingency fund of 10-20% to account for unexpected expenses. Unexpected costs can arise from: design changes during construction, price increases for materials, site conditions requiring additional work (rock excavation, soil remediation), permit delays, weather delays extending labor costs, and upgrading finishes during construction. These factors are common in construction projects and contribute to why actual costs often differ from initial estimates.

Construction Timeline: How Long Does It Take to Build a House?

The typical home construction timeline ranges from 6-12 months for most custom single-family homes, though this varies based on size, complexity, weather, and builder efficiency. Understanding this timeline helps you plan financially and set realistic expectations.

Pre-Construction (1-3 months)

Finalizing plans, obtaining permits, loan approval, selecting builder, signing contracts. This phase often takes longer than expected due to permit processing times and design revisions.

Foundation & Site Work (2-4 weeks)

Land clearing, excavation, utility installation, foundation pouring and curing. Weather can significantly delay this phase, especially in winter or rainy climates.

Framing & Rough-In (2-3 months)

Frame construction, roof installation, window and door installation, rough plumbing, electrical, and HVAC. This is when your home really starts taking shape.

Finishing Work (2-3 months)

Insulation, drywall, interior trim, cabinets, countertops, flooring, painting, fixture installation, landscaping. Detail work takes time and requires coordination of multiple specialty trades.

Final Inspection & Closing (1-2 weeks)

Final walk-through, punch list items, building inspection, certificate of occupancy, loan conversion. This phase typically involves thorough verification that all construction items are completed satisfactorily.

Factors that extend timelines: Complex architectural designs, custom finishes and materials, poor weather conditions, supply chain delays, labor shortages, permit and inspection delays, and change orders during construction all commonly impact project schedules. Construction timelines are estimates, and actual completion dates can vary based on these and other factors.

Builder Selection: Understanding General Contractor Qualifications

General contractors and custom home builders manage construction projects from start to finish. Builders coordinate subcontractors, order materials, manage schedules, and ensure work meets building codes and contract specifications.

Common Builder Qualifications and Credentials

Contractor licenses: States regulate contractor licensing with varying requirements and verification processes
Insurance coverage: General liability insurance and workers' compensation insurance are standard in the industry
Experience levels: Contractors have varying years of experience and portfolios of completed projects
References: Past client experiences and completed project examples provide information about contractor performance
Business structure: Contractors may be bonded, incorporated, or operate under different business structures
Contract terms: Construction contracts typically include scope of work, payment schedules, timelines, change order processes, and warranty information
Communication practices: Contractors have different communication styles and responsiveness levels

Payment structure variations: Standard payment schedules typically involve 10-30% at contract signing, with remaining payments tied to construction milestones. Payment structures vary among contractors. Contract documentation, reference availability, insurance verification, and pricing variations are factors that exist in the contractor evaluation process. Significant price differences among bids can reflect differences in materials, labor quality, overhead costs, or project scope interpretation.

Builder selection processes vary among borrowers. Questions about the construction process, change order procedures, typical timelines, warranty coverage, and problem resolution processes are commonly part of contractor discussions. Price, experience, communication style, and work quality are factors that borrowers consider during the selection process.

Construction Loan vs Traditional Mortgage: Key Differences

Feature	Construction Loan	Traditional Mortgage
Purpose	Fund new construction or major renovation	Purchase existing home
Loan Term	Short-term (6-18 months during construction)	Long-term (15-30 years)
Fund Disbursement	Staged draws as construction progresses	Lump sum at closing
Interest During Construction	Interest-only on drawn amount	N/A (home already exists)
Interest Rate	Typically variable, 1-2% higher	Fixed or variable, lower rates
Down Payment	20-25% typically required	As low as 3-5% for some programs
Qualification Requirements	More stringent, detailed documentation	Standard credit, income, DTI verification
Appraisal Type	Based on projected completed value	Based on current market value
Inspections	Multiple inspections throughout construction	Single pre-purchase inspection
Closing Costs	Often higher, may require two closings	Standard 2-5% of purchase price

Construction Project Factors and Considerations

Design and planning phases

Construction projects involve design and planning phases before ground breaking. Changes during active construction typically cost more and take longer than changes made during the planning phase. Material selections, fixture choices, and design details are decisions that occur at various points in the project timeline.

Budget structures and contingencies

Construction budgets vary in their structure and detail. Many construction projects include contingency funds of 15-20% to account for unexpected expenses. Cost overruns occur in construction projects for various reasons including material price increases, design changes, and unforeseen site conditions.

Communication channels in construction projects

Construction projects involve communication between borrowers, lenders, and contractors. Site visits, draw request reviews, and issue resolution are activities that occur during construction. Communication frequency and methods vary among projects and participants.

Documentation in construction projects

Construction projects generate documentation including contracts, change orders, payment records, and communications. Formal change order processes exist to document modifications to the original construction plan. Written records serve as reference points if questions or disputes arise during or after construction.

Draw schedules and inspection processes

Construction loan draw schedules specify when funds are released and what construction milestones must be completed for each disbursement. Lenders conduct inspections to verify work completion before releasing funds. Draw and inspection requirements vary by lender and loan program.

One-time close vs two-time close structures

One-time close construction-to-permanent loans involve one closing and one set of closing costs, with interest rates locked at the initial closing. Two-time close loans involve separate closings for construction and permanent financing, with two sets of closing costs and exposure to rate changes between closings. Each structure has different cost and timing characteristics.

Frequently Asked Questions About Construction Loans

Get answers to common questions about construction loan financing, qualification requirements, and the home building process.