How Do Construction Loans Work?
A construction loan is short-term financing that funds the building of a new home in stages (draws) as construction progresses. Once the home is complete, the construction loan converts to a permanent mortgage — either automatically (construction-to-permanent or 'one-time close') or through a separate refinance. Construction loans typically require 10-20% down payment, have higher interest rates than permanent mortgages (often 1-2% above conventional rates), and charge interest only on the amount drawn during construction. The build phase usually lasts 6-12 months, during which the lender disburses funds based on inspections confirming completed milestones.
Key Facts
One-Time Close vs. Two-Time Close
There are two main construction loan structures. A one-time close (construction-to-permanent) loan closes once, funds the construction phase with interest-only payments, and automatically converts to a permanent mortgage when the home is complete — no second closing, no second set of closing costs, and the permanent rate is locked at the initial closing. A two-time close requires separate closings for the construction loan and the permanent mortgage, with two sets of closing costs and rate uncertainty on the permanent loan. One-time close is almost always the better option for owner-occupied new construction because it eliminates the risk of rate changes and saves $3,000-$8,000 in duplicate closing costs.
The Draw Schedule: How Funds Are Released
Construction loans don't fund the entire loan amount at closing. Instead, funds are released in draws — typically 4-6 stages aligned with construction milestones. A common draw schedule: foundation complete (15-20%), framing and roof (20-25%), rough mechanical (plumbing, electrical, HVAC — 15-20%), drywall and interior finishes (15-20%), and final completion (20-25%). Before each draw, the lender sends an inspector to verify the work is complete and matches the approved plans. You only pay interest on the cumulative amount drawn — not the full loan amount — which keeps costs lower during the early stages of construction.
Qualifying for a Construction Loan
Construction loans require more documentation than a standard purchase mortgage. In addition to standard income, credit, and asset verification, you'll need: approved architectural plans and specifications, a detailed construction budget with line-item costs, a signed construction contract with a licensed, insured general contractor (most lenders require the contractor to have specific minimum experience and financial qualifications), proof of land ownership or a concurrent land purchase plan, and a completed appraisal based on the plans and specs (an 'as-completed' appraisal). Down payments typically range from 10-20% of the total project cost — which includes land value plus construction costs.
Construction Loan Costs and Timeline
During the construction phase, you make interest-only payments on the amount drawn. Since early draws are smaller, your initial payments are low and increase as more funds are disbursed. Construction loan rates are typically 1-2% above conventional permanent rates — but the construction phase is short (6-12 months), so the total interest cost is manageable. Once the home passes final inspection and receives a certificate of occupancy, the loan converts to its permanent terms — typically a 15- or 30-year fixed-rate mortgage at the rate locked at closing. Budget 6-12 months for construction, plus 30-60 days for the permanent conversion.
Licensed in Oregon & California · NMLS #1498678