Most people who build a house need a construction loan. It works differently from the mortgage you would take out to buy an existing home, and the differences change how much interest you pay, how your builder gets paid and how much cash you need along the way.
The key idea is simple. A regular mortgage pays the whole loan amount at closing. A construction loan pays out in stages, called draws, as the house is built, and during construction you usually pay interest only on the money that has been drawn so far. Federal disclosure rules are written around exactly that structure.[1][2] This guide explains how the pieces fit together and what to budget for.
Key takeaways
- Construction loans are paid out in draws as work is completed and inspected, not as one lump sum.
- During construction, payments are usually interest-only and charged on the amount drawn, so interest rises as the house goes up.
- A one-close (construction-to-permanent) loan rolls into a mortgage automatically; a two-close loan needs a second loan and closing.
- Budget for interest during construction, fees, inspections and the cash you must put in before the lender starts funding.
How a construction loan works
A construction loan has two phases. During the construction phase, the lender releases money in draws to pay for completed work. During the permanent phase, the balance becomes an ordinary mortgage that you repay over a long term, or it is paid off by a separate mortgage.
In the construction phase, payments are typically interest-only. The CFPB's Regulation Z describes construction loans where "interest is payable only on the amount actually advanced for the time it is outstanding", and its disclosure guide for construction loans treats the construction phase as an interest-only period.[1][2] In plain terms: early in the build you owe interest on a small balance, and by the end you owe interest on nearly the whole loan.
Lenders underwrite construction loans more closely than ordinary mortgages because there is no finished house to secure the loan at the start. Expect them to review your plans, the builder's contract and budget, the builder's license and insurance, and an appraisal of what the house will be worth when finished.
Draw schedules and inspections
The draw schedule is the list of milestones at which money is released. It is agreed before closing and usually written into the loan documents and the building contract. A typical schedule follows the stages of construction:
| Milestone | What has to be finished |
|---|---|
| Lot (if financed) | Land purchase at closing |
| Foundation | Footings and slab, crawl space or basement walls |
| Framing / dry-in | Structure, roof, windows and exterior doors |
| Rough-ins | Plumbing, electrical and HVAC run and inspected |
| Drywall and interior | Insulation, drywall, trim and cabinets |
| Completion | Finishes, final inspection, certificate of occupancy |
Before each draw, the lender usually sends an inspector to confirm the work is done. Some lenders pay the builder directly; others pay you, or pay you and the builder jointly. Ask how long each draw takes to be funded after the inspection, because a slow draw can hold up the next trade.
Watch for draw gaps
Builders often have to pay suppliers and subcontractors before the next draw comes in. Ask your builder how the draw schedule matches their payment schedule. A mismatch can mean delays or requests for cash from you mid-build.
One-close vs two-close loans
There are two common structures. The CFPB's rules cover both: construction financing disclosed separately, and construction and permanent financing disclosed as one transaction.[1]
| One-close (construction-to-permanent) | Two-close (construction-only, then mortgage) | |
|---|---|---|
| Closings | One | Two |
| Mortgage at completion | Converts automatically | You apply for a new mortgage |
| Closing costs | Usually one set | Usually two sets |
| Rate risk | Permanent terms can be set up front | Permanent rate depends on rates at completion |
| Flexibility | Less: tied to one lender | More: you can shop for the mortgage later |
A one-close loan saves paperwork and closing costs and protects you if you qualify now but are worried about qualifying later. A two-close loan can make sense if you expect rates to fall, plan to sell another home first, or want to shop for the best mortgage once the house is finished. Ask each lender how the rate on the permanent phase is set and whether it can change at conversion.
What a construction loan costs
Beyond the interest rate, a construction loan comes with costs that are easy to underestimate:
- Interest during construction. Charged monthly on the amount drawn.
- Origination and lender fees, often higher than on a standard mortgage because of the extra administration.
- Appraisal based on plans and specifications.
- Draw inspection fees, sometimes charged per inspection.
- Title updates at each draw to make sure no liens have been filed.
- Closing costs, once for a one-close loan, twice for a two-close loan.
- Rate-lock extension fees if construction runs past the lock period.
Builders face the same costs when they finance spec homes. In the NAHB 2024 survey, the builder's financing cost averaged $10,220, or 1.5% of the sales price.[3] On a custom home you pay for the financing directly, so it belongs in your budget.
How to estimate interest during construction
Because the balance grows with each draw, a quick estimate is to take the average balance outstanding during the build and multiply it by the rate and the number of months. If draws are spread fairly evenly, the average balance is roughly half the loan.
Worked example (illustration only)
Loan amount: $400,000. Build time: 12 months. Interest rate: 8% a year (a round number for the math, not a quote). Average balance ≈ $400,000 ÷ 2 = $200,000. Interest ≈ $200,000 × 0.08 × 12 ÷ 12 = $16,000 over the build.
If the build runs three months late with almost the whole loan drawn, add about $400,000 × 0.08 × 3 ÷ 12 = $8,000.
The second number is why delays matter so much. NAHB analysis of Census data shows custom homes built by a hired contractor averaged 11.7 months from permit to completion in 2025, longer than homes built for sale.[4] See how long it takes to build a house for the full figures.
Cash you need before and during the build
Lenders generally want you to have equity in the project before they start funding. That can be cash, or the value of land you already own. They will also want to see reserves to cover overruns, because a half-built house is hard to sell.
Plan for cash at these points:
- Land purchase, if it is not financed, and its closing costs.
- Design, surveys, soil tests and permit fees, which often come before the loan closes.
- Your down payment or required equity at closing.
- Change orders and upgrades, which lenders often require you to pay in cash.
- Interest payments during the build, alongside your current rent or mortgage.
- Items the loan does not cover, such as some landscaping, furniture and window coverings.
Our land-to-move-in checklist lists these costs phase by phase, and the hidden costs guide explains the ones most people forget.
Common construction loan problems and how to avoid them
Most construction loan trouble comes from a gap between the loan, the contract and what actually happens on site. A few habits prevent most of it.
- The appraisal comes in low. The lender lends against the finished value. If the appraisal is below the contract price plus land, you cover the gap in cash. Ask the lender how they appraise custom homes before you finalize the design.
- The budget has no room for overruns. If the loan is sized exactly to the contract, every change order comes out of your pocket. Ask whether a contingency can be built into the loan amount.
- Liens. If the builder does not pay a supplier or subcontractor, they may file a lien on your property. Many lenders ask for lien waivers with each draw; ask for copies.
- The loan term runs out. Construction phases have a fixed term. If the build runs long, you may face extension fees or a rate change. Match the term to a realistic schedule, not an optimistic one.
- Paperwork delays draws. Keep invoices, inspection reports and change orders organized so each draw request goes through the first time.
Questions to ask lenders
- Do you offer one-close, two-close, or both? What are the rates and fees for each?
- How is the permanent rate set, and can it change at conversion?
- How much equity or down payment do you require, and can land I own count toward it?
- How many draws are allowed, who inspects, and what does each inspection cost?
- How quickly are draws funded after inspection, and who receives the money?
- What happens if construction runs past the loan term? Are there extension fees?
- Do you need to approve my builder? What documents do you require from them?
- How do you handle change orders that increase the cost?
Ask at least three lenders, including a local bank or credit union that does construction lending regularly. Once you know your monthly payment after completion, check it in our mortgage calculator.
Plug your house size, land price and quotes into the free calculator. It uses the same NAHB 2024 averages as this guide.
Frequently asked questions
Do you pay interest on the full construction loan?
Usually not during construction. Interest is typically charged only on the money that has been drawn, so payments start small and grow as the house is built.
What is a construction-to-permanent loan?
It is a single loan that funds construction and then becomes your long-term mortgage, with one closing. It is also called a one-close or single-close loan.
Who gets the money from a construction loan draw?
It depends on the lender. Some pay the builder directly, some pay the borrower, and some issue joint payments. Ask before you close.
Can I use land I already own as a down payment?
Many lenders count equity in land you own toward the required equity for a construction loan. Ask each lender how they value it.
Sources
- CFPB: Regulation Z, Appendix D to Part 1026, Multiple Advance Construction Loans Verified
- CFPB: TILA-RESPA Integrated Disclosures for Construction Loans (guide) Verified
- NAHB: Cost of Constructing a Home 2024 Verified
- NAHB Eye on Housing: Single-Family Home Construction Time Declines in 2025 Verified (third-party copy)
Figures last checked October 18, 2026. National averages are a planning guide, not a quote. See our editorial policy and data sources.
