A construction loan is a short-term, higher-interest loan used to finance the building of a new home. Unlike a traditional mortgage — where you get the entire loan amount at closing — construction loans disburse funds in stages (draws) as the builder completes each phase. The loan term is typically 12-18 months, after which you either pay off the balance by refinancing into a permanent mortgage, or the loan automatically converts if you have a construction-to-permanent loan.
The most popular option. One loan covers both construction and permanent mortgage. You lock in the rate at closing, pay interest-only during construction, and the loan automatically converts to a traditional mortgage when construction is complete. Only one closing → saves on fees and locks your rate upfront. Typically requires 20% down (or equity in the land).
One loan for construction, then a separate mortgage to pay it off. Two closings → higher fees. Interest rate on the permanent mortgage is set at the second closing, which could be higher or lower than today's rates. This option works when you want flexibility on the permanent mortgage or if you're building with your own cash and need bridge financing.
FHA 203(k), Fannie Mae HomeStyle, or Freddie Mac CHOICERenovation — these loans finance both the purchase/refinance AND renovation of an existing home. Not for ground-up construction but covers major renovations. Down payments as low as 3.5% (FHA 203(k)). The renovation funds are held in escrow and disbursed as work is completed.
For borrowers who act as their own general contractor. Harder to qualify for — lenders require proof of construction experience, licensing, and detailed project plans. Higher down payment required (typically 25-30%). Most lenders prefer working with licensed general contractors to reduce risk.
Funds are released in stages (draws) as construction progresses. A typical draw schedule:
| Draw # | Phase | % of Total | What's Covered |
|---|---|---|---|
| 1 | Foundation | 10-15% | Excavation, footings, foundation walls, slab |
| 2 | Framing | 15-20% | Walls, roof trusses, sheathing, windows, exterior doors |
| 3 | Rough-In | 20-25% | Plumbing, electrical, HVAC, insulation |
| 4 | Drywall & Interior | 15-20% | Drywall, painting, interior trim, doors |
| 5 | Finishes | 15-20% | Flooring, cabinets, countertops, fixtures, appliances |
| 6 | Final | 10% | Landscaping, punch list, certificate of occupancy |
Each draw requires an inspection — the lender sends an inspector to verify work is complete before releasing funds.
| Requirement | Typical Standard |
|---|---|
| Credit Score | 680+ (some lenders go to 620; best rates at 720+) |
| Down Payment | 20-25% of total project cost (land + construction). VA: possibly 0% down for eligible veterans. FHA 203(k): 3.5% |
| Debt-to-Income | Max 43-45% DTI |
| Builder Requirements | Licensed, bonded, insured general contractor with proven track record. Lender will vet the builder. |
| Plans & Specs | Detailed architectural plans, cost breakdown, construction timeline, and building permits |
| Reserves | 6-12 months of PITI in reserves after closing. Contingency reserve (5-10% of construction budget) |
| Appraisal | "Subject-to" appraisal — appraiser estimates value based on plans and specs as if the home were complete |