A new construction loan is a short-term loan designed to finance the building of a home from the ground up. Unlike a standard mortgage, which gives you a lump sum to buy an existing house, a construction loan releases money in stages as your home is built and typically requires interest-only payments during the construction phase. Once the house is complete, the loan either converts into a traditional mortgage or gets paid off with a separate one.
How a Construction Loan Works
Construction loans function differently from conventional mortgages in almost every way. The loan term is short, usually 12 to 18 months, covering only the time it takes to build. During that period, you don’t receive the full loan amount at once. Instead, the lender releases funds in a series of payments called “draws,” each tied to a specific construction milestone.
Before each draw is released, the lender sends an inspector to verify the work matches what the builder is requesting payment for. This might happen through an onsite visit, geolocation-verified photos from the job site, or both. The inspection confirms that the foundation was actually poured, the framing is actually up, or the roof is actually on before the next chunk of money goes out. Think of it as the lender checking receipts in real time rather than handing over a blank check.
Because the full loan balance isn’t outstanding from day one, your payments during construction are typically interest-only, calculated on just the amount that’s been disbursed so far. Early in the build, when only a small draw has been released, those payments are relatively small. They grow as the project progresses and more money is released.
Construction-to-Permanent vs. Construction-Only Loans
There are two main structures, and the one you choose affects how many times you close, how much you pay in fees, and how much flexibility you have.
A construction-to-permanent loan (also called a single-close or one-time-close loan) covers the building phase and then automatically converts into a standard 15- or 30-year mortgage once the home is finished. You close once, pay one set of closing costs, and lock in your permanent mortgage terms up front. This is the simpler path for most borrowers because there’s less paperwork, less uncertainty, and lower total fees.
A construction-only loan covers the building phase and nothing else. When construction wraps up, you need to either pay off the loan in full or take out a separate mortgage. That means two closings and two sets of closing costs. The trade-off is flexibility: if rates drop during construction, you can shop freely for a better permanent mortgage without being locked into terms you agreed to months earlier. But you also take on the risk that rates could rise, or that your financial situation could change enough to complicate qualifying for a new mortgage.
Qualification Requirements
Construction loans carry more risk for lenders than standard mortgages. There’s no finished house to use as collateral during the build, and projects can go over budget, stall, or hit permitting snags. Because of that added risk, lenders set a higher bar for approval.
Expect to need a minimum credit score of around 680, though some lenders require 700 or higher. Down payments are also steeper. Most lenders ask for 20% to 25% down, and some require up to 30%, particularly for larger loan amounts. A few lenders will go as low as 10% down for loans under a certain threshold, but that’s the exception rather than the rule.
If you’re a veteran or buying in a qualifying rural area, there are zero-down options. VA construction loans and USDA construction loans both allow you to finance the build without a down payment, though each program has its own eligibility criteria tied to military service or property location.
Beyond your personal finances, the lender will also underwrite the project itself. Your land purchase contract and your builder contract both go through review. The lender wants to see that the budget is realistic, the timeline is achievable, and the finished home will appraise at or above the loan amount.
What Lenders Require From Your Builder
You can’t just hire anyone and expect a lender to write the check. Most lenders require the builder to be vetted and approved before the loan closes. At minimum, the builder needs to carry proper state or local licensing, hold liability insurance, and demonstrate meaningful experience. FHA construction loans, for example, require the contractor to have at least two years of homebuilding experience.
Your builder will also typically need to provide a new construction warranty, which protects you against defects in materials and workmanship for a set period after the home is completed. This warranty isn’t just a nice-to-have; many lenders and loan programs make it a condition of approval.
If you have a specific builder in mind, check with your lender early. Some lenders maintain approved-builder lists, and getting a new builder added can take time. Starting that process before you’re deep into loan applications can prevent delays.
Interest Rates and Costs
Construction loan interest rates are generally higher than rates on a standard 30-year fixed mortgage. The premium reflects the added risk and complexity of lending against a property that doesn’t exist yet. Rates are often variable during the construction phase, meaning they can shift as market conditions change over the months it takes to build.
On top of the interest rate, plan for several costs that don’t come with a typical home purchase. The lender will charge for each inspection during the draw process. You’ll also pay for an appraisal based on the plans and specifications (called an “as-completed” appraisal), title insurance, and the standard closing costs you’d see on any mortgage. If you go with a construction-only loan and refinance into a permanent mortgage later, you’ll pay closing costs twice.
The Construction Timeline
Most construction loans give you 12 to 18 months to complete the build. During that window, your builder submits draw requests at each major milestone: site preparation, foundation, framing, mechanical systems (plumbing, electrical, HVAC), and finishing work. Each draw request triggers an inspection, and funds are released only after the inspector confirms the work is done.
If construction runs past the original loan term, you may need to request an extension from the lender, which can come with additional fees. Delays happen frequently in new construction due to weather, material shortages, permitting holdups, or subcontractor scheduling. Building a realistic timeline with your builder and padding it by a few months can help avoid the stress and cost of needing an extension.
Once the home passes its final inspection and receives a certificate of occupancy, the construction phase ends. If you have a construction-to-permanent loan, your payments shift from interest-only to full principal-and-interest payments on your new mortgage. If you have a construction-only loan, the clock starts on paying off or refinancing the balance.
Who Construction Loans Are For
Construction loans make sense when you’re building a custom home on land you own or plan to purchase, or when you’re buying from a builder who doesn’t offer their own financing. They’re also used for major renovations that essentially rebuild a home from the studs out, though renovation-specific loan products (like the FHA 203(k)) sometimes overlap with that use case.
If you’re buying a new-build home in a planned development where the builder has already started or completed the house, you probably don’t need a construction loan at all. A standard purchase mortgage works in that scenario because there’s a finished (or nearly finished) property to serve as collateral. Construction loans are specifically for situations where the house hasn’t been built yet and you need to fund the process of building it.