Inside U.S. Construction Loans: Stages, Rates, and Repayment

Answer

Construction loans provide short-term financing to cover costs of building a home from the ground up. Unlike a traditional mortgage, these loans fund each stage of construction through a draw schedule, helping you manage cash flow until the project is complete.

During the build, lenders release funds in phases—foundation, framing, plumbing, and final inspection—after verifying progress. Borrowers typically make interest-only payments on the outstanding balance. Once construction finishes, you can either pay off the loan in full or convert it into a long-term mortgage through a construction-to-permanent loan.

Key features you should know:

• Loan term: Usually 6–12 months, matching your build timeline.
• Interest rates: Often 1–2 points above conventional mortgage rates, ranging from about 6% to 9% APR.
• Down payment: Lenders require 20–25% of total project costs, plus a 5–10% contingency reserve for overruns.
• Draw inspections: A third-party inspector or your lender’s agent confirms each stage before releasing funds.
• Conversion options: Standalone construction loans require a separate closing on a permanent mortgage, while construction-to-permanent loans streamline financing with one application and closing.

To qualify, prepare a detailed budget, building plans, and a licensed contractor’s agreement. Lenders will review your credit score, debt-to-income ratio, and the project’s feasibility. Some borrowers also need to provide proof of land ownership if the lot isn’t already paid off.

Before breaking ground, discuss timelines and costs with your lender and contractor to avoid surprises. Buyers are recommended to verify local permit requirements and review estimated closing costs on both the construction loan and subsequent mortgage.

By understanding draw schedules, payment structure, and conversion mechanics, you can secure the right construction financing for your new home. It’s advisable to consult a licensed attorney or mortgage professional familiar with your state’s regulations before closing any deal.