What is a Construction Loan?
Construction loans finance the building of a new home. Unlike traditional mortgages that provide a lump sum, construction loans disburse funds in stages as construction milestones are completed (draws).
During construction, you typically make interest-only payments on funds drawn. Once construction is complete, the loan either converts to a permanent mortgage (construction-to-permanent) or must be paid off/refinanced (construction-only).
How to Use This Calculator
Step 1: Enter land cost (if not already owned).
Step 2: Input estimated construction costs.
Step 3: Add contingency percentage (typically 10%).
Step 4: Enter down payment amount.
Step 5: Input interest rate and construction timeline.
Step 6: Select loan type and click "Calculate".
Types of Construction Loans
- Construction-to-Permanent: Single loan that converts to mortgage after construction. One closing, one set of fees, rate locked at start or end depending on program.
- Construction-Only: Short-term loan (6-12 months) for construction only. Must be paid off or refinanced upon completion. Two closings, two sets of fees.
- Renovation Loans: For major home improvements. FHA 203(k) and Fannie Mae HomeStyle are popular options.
- Owner-Builder: For experienced builders acting as their own general contractor. Difficult to qualify, higher rates.
Construction Loan Requirements
- Detailed Plans: Architectural drawings and specifications.
- Builder Contract: Fixed-price contract with licensed builder.
- Construction Timeline: Detailed schedule of work phases.
- Higher Down Payment: Typically 20-25% minimum.
- Strong Credit: 700+ preferred, higher scrutiny than purchase loans.
- Appraisal: Based on plans and specs (future value).
- Reserves: 6-12 months payments in savings.
Understanding Construction Costs
Budget categories for custom home building:
- Land: Purchase price or value if already owned.
- Hard Costs: Materials and labor (typically $150-300/sq ft).
- Soft Costs: Permits, fees, design, engineering (10-15% of project).
- Contingency: 10% buffer for unexpected costs (essential).
- Landscaping: Often overlooked in initial budgets.
- Finishing: Interior finishes vary wildly in cost.
Frequently Asked Questions
How much down payment do I need for a construction loan?
Typically 20-25% of total project cost (land + construction). Some programs allow 10% with excellent credit. The down payment covers cost overruns and protects the lender. Equity in owned land can count toward down payment.
Are construction loan rates higher than mortgages?
Yes, typically 0.5-1% higher during construction phase. Construction-to-permanent loans may lock in permanent rate upfront or float until conversion. Construction-only loans have short-term rates that convert to permanent financing later.
How do construction loan draws work?
Funds are released in stages after inspections verify work completion. Typical draws: foundation, framing, mechanicals, drywall, final completion. You pay interest only on drawn amounts, not the full loan. Each draw requires inspection and paperwork.
What is a one-time close construction loan?
Also called construction-to-permanent or single-close loan. One application, one approval, one closing, one set of closing costs. Converts to permanent mortgage automatically after construction. Simpler and often cheaper than two separate loans.
Can I act as my own general contractor?
Owner-builder loans exist but are difficult to get. Lenders want experienced builders. You'll need to prove construction expertise, possibly through licenses or portfolio. Rates are higher, down payment requirements larger.
What happens if construction goes over budget?
You're responsible for overruns. That's why 10% contingency is crucial. Some lenders hold contingency funds and release only if needed. If overruns exceed contingency, you pay out of pocket or modify plans. Good planning prevents most overruns.
How long does construction loan approval take?
Typically 45-60 days, longer than purchase loans. Requires plan review, builder approval, detailed appraisal (future value based on plans), and multiple inspections. Start early and have detailed plans ready.
Can I use a construction loan to buy land and build?
Yes, most construction loans include land purchase if you don't already own it. Land value counts toward your down payment/equity. Some buyers purchase land first with cash or land loan, then get construction loan.
What's included in construction loan interest?
During construction, you pay interest only on funds actually drawn. Average balance is about half the loan amount over construction period. After conversion to permanent loan, you pay full principal and interest amortized over loan term.
Do I need builder's risk insurance?
Yes, required by lenders. Builder's risk insurance covers damage during construction (fire, theft, weather). Your builder may carry it, or you may need to purchase. Also requires general liability and workers comp from builder. Verify coverage before starting.
Can I get a construction loan with bad credit?
Difficult. FHA construction-to-perm loans accept lower scores (580+) but require more down payment. Conventional construction loans typically need 700+. Work on credit before applying—construction loans have stricter requirements than purchase loans.
What is interest reserve in construction loans?
Some loans include interest reserve—funds to make construction period interest payments, so you pay nothing during building. Adds to loan amount and total interest paid. Useful if paying rent/mortgage elsewhere during construction.