Building a custom home requires a construction loan — a short-term loan that funds the building phase before converting to a permanent mortgage. Here is everything you need to know.
Construction Loan — Key Facts
Types of Construction Loans
- Construction-to-permanent (one-time close): One loan, one closing. Converts automatically to a permanent mortgage when construction is complete. Lower total closing costs. More common and preferred by most borrowers.
- Two-close construction loan: Separate construction loan (closed first) and permanent mortgage (closed at completion). More flexibility to change lenders or loan terms at completion. Two sets of closing costs.
- Owner-builder loans: For homeowners who will act as their own general contractor. Very difficult to qualify — most lenders won't do them unless you're a licensed builder.
How Construction Loan Draws Work
Construction loans are disbursed in "draws" — scheduled payments to the builder as construction progresses. Typical draw schedule: 15% foundation complete, 25% framing, 20% mechanical (plumbing, electrical, HVAC), 20% drywall and insulation, 20% completion/certificate of occupancy. Each draw typically requires a bank inspector to verify completion of the corresponding phase.
Down Payment Requirements
Construction loans typically require 20–25% down. Some lenders count land equity toward the down payment if you already own the lot. There are some low-down-payment options: FHA construction-to-permanent loans require just 3.5% down, and VA construction loans are available for eligible veterans with 0% down.
Frequently Asked Questions
A construction loan is short-term (6–18 months) with variable rates and interest-only payments during the build phase. It disburses funds in stages (draws) as construction progresses rather than as a lump sum. A permanent mortgage is long-term (15–30 years) with fixed or adjustable rates and full amortizing payments. The construction loan converts to a permanent mortgage upon completion.
Construction loans typically require a higher credit score than standard mortgages — most lenders require 680–700 minimum, with 720+ for better rates. Because construction risk is higher (project delays, cost overruns, builder failure), lenders are more conservative in their underwriting requirements.