Construction Loans: How to Finance Building a Home
Last updated: October 2026 · Editorial standards
Building a home from the ground up requires a different type of financing than buying an existing property. Construction loans are short-term, specialized products — and they work very differently from a traditional mortgage.
What Is a Construction Loan?
A construction loan is a short-term loan that provides funds to build a home. Unlike a mortgage (which is disbursed in full at closing), construction loans release money in stages as building progresses.
Most construction loans have a term of 12 to 18 months — just long enough to complete construction. Once the home is finished, you either pay off the loan or convert it into a permanent mortgage.
How Construction Loans Work
Draw Schedule
Instead of receiving the full loan amount upfront, you draw funds in stages based on construction milestones. A typical draw schedule might include:
- Foundation: 10–15% of loan
- Framing: 15–20%
- Mechanical rough-in (plumbing, HVAC, electrical): 15–20%
- Insulation and drywall: 10–15%
- Interior finishes: 15–20%
- Final completion: 10–15%
Before each draw is released, the lender may send an inspector to verify the work is complete.
Interest-Only Payments During Construction
During the construction period, you only pay interest on the funds actually drawn — not the full loan amount. As more money is drawn, your monthly payment increases.
Loan Conversion or Payoff at Completion
When construction is complete, either:
- One-time close: The construction loan automatically converts to a permanent mortgage (set up at the beginning)
- Two-time close: You pay off the construction loan by getting a new permanent mortgage
Types of Construction Loans
Construction-to-Permanent Loan (One-Time Close)
The most common and convenient option. One loan, one closing, one set of closing costs. The loan starts as a construction loan and converts to a 30-year (or other term) mortgage when construction is complete.
Stand-Alone Construction Loan (Two-Time Close)
Two separate loans and two sets of closing costs. You get a construction loan for building, then apply for a separate mortgage when the home is done. More paperwork and cost, but sometimes necessary if construction takes longer than expected.
FHA Construction-to-Permanent Loan
Available through FHA-approved lenders for lower credit scores and smaller down payments. Requires FHA appraisal and inspection standards.
VA Construction Loan
Available to eligible veterans and service members. No down payment required. VA-specific requirements apply.
USDA Construction Loan
For rural properties that meet USDA program requirements.
Qualifying for a Construction Loan
Construction loans are harder to qualify for than standard mortgages because the collateral (the finished home) doesn’t exist yet.
Typical requirements:
- Credit score: 680+ for most conventional construction loans; some lenders require 720+
- Down payment: Usually 20–25% (though FHA and VA programs allow less)
- Detailed construction plans: Architectural drawings, specs, and a construction contract
- Licensed builder: Most lenders require a licensed, insured general contractor
- Construction budget and timeline: Reviewed and approved by the lender
- Land: Either owned outright or being purchased as part of the transaction
The Builder Approval Process
Your lender will vet your builder, including:
- License verification
- Insurance (general liability and workers’ compensation)
- Credit and financial stability
- References and completed projects
- No history of liens or disputes
Owner-builder loans (where you act as your own general contractor) are offered by some lenders but are harder to qualify for and carry higher risk.
Construction Loan Interest Rates
Construction loan rates are typically 1–3% higher than standard mortgage rates. The exact rate depends on your credit, the lender, and market conditions.
Because construction loans are short-term (often 12 months) and carry higher risk for the lender, the premium is expected.
Costs to Budget For
Beyond the construction itself, plan for:
- Loan origination fees: 1–2% of loan amount
- Appraisal fee: Higher for new construction ($400–$1,000+)
- Inspection fees: Each draw inspection costs $100–$300
- Contingency reserve: Plan for 10–15% over budget — construction almost always has surprises
- Carrying costs: Rent during construction plus loan interest payments
Key Takeaways
Construction loans are complex but manageable with the right preparation. Choose a one-time close loan when possible to save on closing costs. Have your builder vetted before applying, and budget a healthy contingency reserve — construction timelines and costs rarely go exactly as planned.
Frequently Asked Questions
Can I use a construction loan to buy land? Yes, many construction loans include the land purchase in the total loan amount.
What happens if construction takes longer than the loan term? You can usually request an extension, though the lender may charge a fee. Budget enough contingency time to avoid this situation.
Can I act as my own general contractor? Some lenders offer owner-builder construction loans, but qualification requirements are stricter and interest rates may be higher.
Do I need to own the land first? Not necessarily — many lenders allow you to purchase land and finance construction in one loan.
