A new construction loan works by financing a home build in stages: you close on the loan, then the lender releases money in scheduled draws as your builder finishes milestones, and you pay interest only on what has actually been disbursed. The building phase usually runs 12 to 18 months. When the home is done, the loan either converts automatically into a long-term mortgage or gets paid off by a separate permanent mortgage you close on at that point. Which of those two paths applies is the first thing to nail down, because it shapes your closings, your fees, and your rate risk.
Single-Close and Two-Close Loans
Construction financing comes in two structures.
A construction-to-permanent loan, also called a one-time close or single-close loan, combines the build financing and the long-term mortgage into one agreement. You sit at one closing table, pay one set of closing costs (typically 2 to 5 percent of the total loan amount), and the loan converts to a permanent mortgage automatically once construction is finished. The rate for the permanent phase is generally locked at or before closing, which shields you from rate increases during a long build. In exchange, you commit to a single lender for both phases and cannot shop the permanent mortgage separately.
A stand-alone construction loan covers only the building period. Once the home is finished, you pay off that short-term balance by closing on a separate permanent mortgage, going through the full closing process a second time.1Fannie Mae. Two-Closing Construction to Permanent Financing Transaction Process The advantage is that you can shop lenders for the permanent rate after the home is built and appraised. The cost is two rounds of closing fees, plus the risk that rates move against you between the two closings.
How the Draw Schedule Releases the Money
After closing, the lender does not hand over the loan balance. Funds come out in disbursements called draws, each one tied to a construction milestone. A typical residential build has about five stages:
- Site work and foundation: excavation, grading, and pouring the foundation.
- Framing and roofing: structural walls, roof trusses, and exterior sheathing.
- Mechanical rough-ins: plumbing, electrical wiring, and HVAC ductwork before drywall closes the walls.
- Interior finishes: drywall, flooring, cabinets, fixtures, and paint.
- Final completion: punch-list items, landscaping, and cleanup before the certificate of occupancy.
When the builder completes a milestone, they submit a draw request. A third-party inspector visits the site to confirm the work is actually done and meets code. Inspection fees typically run $100 to $250 per visit and are often deducted from loan proceeds. If the inspection passes, the lender releases payment, either directly to the builder or as a joint check payable to you and the builder together.
Each draw is tracked against the approved budget so the remaining balance stays sufficient to finish the home. Many lenders also run a title check before releasing each draw to catch any new liens, such as mechanic’s liens from unpaid subcontractors, that would have to be cleared before more money moves.
What You Pay During the Build
Construction loan interest rates are almost always variable during the building phase, calculated as the prime rate plus a lender-set margin. As of early 2026, the bank prime rate sits at 6.75 percent.2Federal Reserve. H.15 – Selected Interest Rates (Daily) Most lenders add one to two percentage points, putting construction rates in the mid-to-high single digits. Because the rate floats, your monthly cost can shift if the Federal Reserve adjusts its benchmark.
Payments during construction are interest-only, calculated on the amount actually drawn rather than the full approved loan.3Consumer Financial Protection Bureau. TILA-RESPA Integrated Disclosures for Construction Loans Guide If only $80,000 of a $400,000 loan has been disbursed for the foundation and framing, that month’s interest is calculated on $80,000. As draws are released, the payment climbs.
Some lenders offer an interest reserve, a portion of the loan set aside to cover those monthly interest payments during the build. Instead of writing a check each month, the lender deducts the payment from the reserve. Interest still accrues on the reserve balance itself, which slightly increases your total borrowing cost.4Consumer Financial Protection Bureau. Comment for Appendix D – Multiple-Advance Construction Loans
What Lenders Require to Approve You
Qualifying for a construction loan is harder than qualifying for a standard purchase mortgage because the collateral does not exist yet. Expect stricter thresholds.
Your Financial Profile
Most lenders look for a minimum credit score of 680, and a score of 720 or higher tends to unlock better rates. Debt-to-income generally needs to stay below 43 percent. Plan on a down payment of at least 20 percent of total project costs on a conventional construction loan. You will provide recent pay stubs, two years of tax returns, and proof of assets.
Your Builder
Lenders vet the builder almost as closely as they vet you. The application needs to include a signed construction contract with the scope of work, material selections, and a completion timeline, along with a detailed line-item budget covering every cost category from site work through landscaping. The lender also reviews the builder’s contractor license, general liability insurance, workers’ compensation coverage, and track record. Missing items usually stop the file.
The As-Completed Appraisal
Because the home does not exist, the lender orders an “as-completed” appraisal. The appraiser reviews the plans, specifications, and comparable sales to estimate what the finished property will be worth. Lenders then size the loan using the more conservative of two ratios: loan-to-cost (loan divided by total project cost) and loan-to-value (loan divided by estimated completed value).
Acting as Your Own Builder
If you plan to serve as your own general contractor, options narrow. Few lenders offer owner-builder construction loans, and those that do usually require documented construction experience or enrollment in an owner-builder program, plus a more detailed schedule, a larger contingency reserve, and proof of subcontractor agreements. Terms are typically stricter: more equity, shorter draw intervals, and closer oversight.
Down Payment, Land Equity, and Lower-Down-Payment Programs
If you already own the lot, the equity you hold in it can usually count toward your down payment. On a $500,000 project, a fully paid-off lot appraised at $100,000 can cover the 20 percent down payment requirement outright. If you still owe on the land, only the difference between appraised value and remaining balance counts. If you have not bought the lot yet, many construction loans can roll the land purchase into the total financed amount, so a single transaction covers acquisition, construction, and permanent financing.5USDA Rural Development. Single Family Housing Guaranteed Loan Program Combination Construction to Permanent Loans
If a 20 percent down payment is out of reach, three government-backed programs lower the bar.
FHA One-Time Close Loans
The Federal Housing Administration backs single-close construction-to-permanent loans with a down payment as low as 3.5 percent of total project cost, including land. Credit score requirements start around 580 for the 3.5 percent tier, though individual lenders often set higher minimums. FHA loans require both an upfront mortgage insurance premium and monthly mortgage insurance for the life of the loan. Primary residences only.
VA Construction Loans
Eligible veterans, active-duty service members, and qualifying National Guard and Reserve members can build with no down payment. Instead of mortgage insurance, VA loans charge a one-time funding fee: 2.15 percent of the loan for first-time use with no down payment, 1.5 percent with 5 percent down, and 1.25 percent with 10 percent or more down.6Veterans Affairs. VA Funding Fee and Loan Closing Costs The fee can be rolled into the loan. Veterans with a service-connected disability are exempt. Primary residences only.
USDA Construction Loans
The USDA’s Single Family Housing Guaranteed Loan Program offers 100 percent financing on homes built in eligible rural areas, available as a single-close construction-to-permanent loan.7USDA Rural Development. Single Family Housing Guaranteed Loan Program Household income cannot exceed 115 percent of area median income, and the home must be your primary residence. USDA’s definition of rural is broader than most people expect, so check the eligibility map before ruling it out.
Insurance During the Build
Lenders require a builder’s risk policy, sometimes called course-of-construction insurance, before releasing any funds. A standard homeowners policy is written for occupied homes and will not cover a construction site: exposed wiring raises fire risk, materials on-site can be stolen, and the structure sits unoccupied for months. Many homeowners policies contain vacancy clauses that suspend coverage for vandalism or water damage once a property has been unoccupied 30 to 60 days.
Builder’s risk coverage is written for those conditions and typically insures the structure, on-site materials, and sometimes soft costs like extra loan interest if a covered event delays the project. It runs through construction and ends when you get the certificate of occupancy and switch to a permanent homeowners policy. Your builder may carry their own policy, but lenders often want either a separate borrower-held policy or confirmation that you and the lender are listed as additional insureds on the builder’s coverage.
Cost Overruns and Change Orders
Construction rarely follows the plan exactly. Material prices move, sites reveal surprises, and designs change mid-build. Lenders address this by requiring a contingency reserve inside the budget. On conventional construction loans, about 5 percent of construction costs is common. FHA 203(k) rehabilitation loans require more, typically 10 to 20 percent of financeable improvement costs depending on the age and condition of the structure.8HUD. Standard 203(k) Contingency Reserve Requirements
When something needs to change mid-build, you submit a change order to both your builder and your lender. Lenders vary widely in how they handle these. Some treat every change order like a mini loan modification with updated appraisals and committee review. Others let you reallocate funds between line items as long as the total stays put. Before you sign, ask exactly how your lender processes change orders and how long approval typically takes. A three-week turnaround on a small material swap can stall an entire build.
What Happens When Construction Ends
The construction phase ends when your local municipality issues a certificate of occupancy confirming the home meets code and is safe to live in. What comes next depends on the structure you chose.
With a single-close loan, the lender converts the construction debt into the permanent mortgage that was agreed to at closing. Interest-only payments stop and standard principal-and-interest payments begin, typically on a 15- or 30-year term. There is no new closing, and the permanent rate was locked before construction began.
With a two-close loan, you now need to secure a separate permanent mortgage to pay off the construction balance. That means a new application, a new closing, and a second round of closing costs. The lender orders a final appraisal of the completed home to confirm its value supports the permanent loan, along with a final inspection to confirm the scope of work is finished.1Fannie Mae. Two-Closing Construction to Permanent Financing Transaction Process Once the permanent mortgage closes, the construction loan is paid off and long-term repayment begins.
Deducting Construction Loan Interest
Interest paid on a construction loan can be deductible as home mortgage interest, with a time limit. The IRS lets you treat a home under construction as a qualified home for up to 24 months, starting any time on or after the day construction begins. The home has to actually become your qualified residence once it is ready for occupancy; if you never move in, the deduction is lost retroactively.9Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction
The usual home mortgage interest limits apply: interest on up to $750,000 of total home acquisition debt ($375,000 if married filing separately) for loans taken after December 15, 2017.9Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction If your construction loan plus any existing mortgage exceeds that threshold, only the interest attributable to the first $750,000 qualifies. Keep detailed records of draw dates and interest payments throughout the build, because your lender may not issue a standard Form 1098 for the construction phase.