11/12/2025
How construction 🚧 loan works.
Construction loans are short-term, higher-interest loans that fund the building of a new home. Unlike traditional mortgages, which provide a lump sum, these funds are disbursed in stages ("draws") as construction progresses and are typically repaid on an interest-only basis during the building phase.
Key Features and Process
Application and Approval: The process is more rigorous than for a traditional mortgage. Lenders require the borrower to submit detailed construction plans, a budget, and a signed contract with a licensed builder. The lender will also vet the builder's credentials and order an appraisal based on the future value of the completed home.
Disbursement (Draws): Once approved, the lender sets up a "draw schedule" tied to specific construction milestones (e.g., foundation laid, framing complete, interior systems installed). Before releasing each payment to the builder, an inspector or appraiser verifies the work is completed correctly.
Payments During Construction: During the construction period (typically 6 to 18 months), the borrower usually only makes interest payments on the amount of money drawn so far.
Completion and Conversion: Once construction is complete and a certificate of occupancy is issued, the loan must be paid off. This leads to the two main types of construction loans:
Construction-to-Permanent (Single-Close): The construction loan automatically converts into a permanent, long-term mortgage (15- or 30-year term). This option is popular because it involves a single application and one set of closing costs.
Construction-Only (Two-Time-Close): The borrower must pay the loan in full at the end of the term, usually by obtaining a separate, permanent mortgage (an "end loan"). This offers flexibility to shop for the best mortgage rates but means paying two sets of closing costs.
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Borrower Requirements
Due to the higher risk for lenders (there is no existing home as collateral), qualifying criteria are often stricter. Borrowers typically need:
A solid credit score (generally 680 or higher).
A down payment of at least 20%, sometimes more.
A low debt-to-income (DTI) ratio and proof of
