Construction loans: paying for a home build in draws
Reviewed by the Editorial Team · Updated October 18, 2026 · 9 min read
A construction loan is short-term financing that pays for building a home, released in draws as each stage is inspected. During the build you pay interest only on the money drawn so far, and when the home is finished the loan converts to a permanent mortgage or is paid off by a new one.
Key takeaways
A construction loan pays for a build in draws released after inspections, and you pay interest only on the money drawn so far.
On a $400,000 loan over 12 months at an illustrative 8.00%, build-phase interest is $19,998, against $32,004 if the full amount were drawn from day one.
Once the home is finished, the permanent payment is $2,710 a month in principal and interest on $400,000 over 30 years at 7.18%, before taxes and insurance.
Conventional lenders commonly ask for 20% down, a score near 680 and a debt-to-income ratio up to 45%; terms vary by lender.
Down payment
Commonly 20%; land equity may count
During the build
Interest only on funds drawn
Credit score
Often 680+ (conventional)
Closings
One (construction-to-permanent) or two
Prime rate today7.00%Fed H.15 via FRED · Oct 27, 2026. Many construction loans are priced off prime.
Interest during a 12-month build$19,998On a $400,000 loan drawn in stages. Stage by stage ↓
How a construction loan works
A construction loan pays your builder in stages instead of handing you the full amount at closing. After each stage passes inspection, the lender releases a draw, and you pay interest only on what has been drawn.
Draws: released after each completed stage is inspected
Payments: interest only on the drawn balance during the build
Approval: the lender vets your builder, plans and itemized budget
Appraisal: values the finished home, not the empty lot
One closing or two
A construction-to-permanent loan closes once and converts to a mortgage when the home is finished. A construction-only loan closes twice: you repay it with a separate mortgage at the end, with a new approval and a second set of closing costs.
How much cash you need up front
Lenders usually lend a percentage of the project's cost or its as-completed appraised value, whichever is lower. At the 20% down that conventional lenders commonly ask, a $500,000 project means a $400,000 loan, the amount in our worked example.
Down payment and loan size at 20% down
How much cash you need up front
Project budget
Down payment
Loan amount
$300,000
$60,000
$240,000
$400,000
$80,000
$320,000
$500,000
$100,000
$400,000
Land you already own can often count toward the down payment, because its equity reduces the cash you must add. Each lender values the lot its own way, so ask how yours will treat it.
What a construction loan really costs
Take a $400,000 loan paid out over a 12-month build. Prime is 7.00%, so an illustrative construction rate of prime + 1 is 8.00%, while the Freddie Mac 30-year average behind the permanent payment is 7.18%. No official average exists for construction rates.
Worked exampleA $400,000 construction loan over a 12-month build
What a construction loan really costs
Build stage
Drawn so far
Monthly interestat 8.00%
Months 1–3
$80,000
$533
Months 4–6
$200,000
$1,333
Months 7–9
$320,000
$2,133
Months 10–12
$400,000
$2,667
After completion: 30-year loan
$400,000
$2,710 P&I at 7.18%
Interest during the build$19,998charged only on money drawn — vs $32,004 if the full $400,000 were out all year
Payment once the home is finished$2,710principal and interest on the permanent loan at today's 30-year average
Construction rate is illustrative: prime 7.00% (Fed H.15, Oct 27, 2026) + 1 percentage point, interest-only on drawn funds. Permanent rate: Freddie Mac PMMS 30-year average 7.18% (Nov 5, 2026). Draw timing, fees and inspection costs vary by lender and builder. Model your own build
Interest follows the drawn balance, so the $533 a month in the first quarter grows to $2,667 by the final stage. Across the year that totals $19,998, against $32,004 if the full $400,000 had been out from day one.
Then the permanent loan takes over at $2,710 a month in principal and interest on $400,000 over 30 years at 7.18%. That is close to the last build month's $2,667, but now part of each payment reduces the balance. Test your own draw schedule in the construction loan calculator.
Two housing costs at once
The totals cover loan interest and principal only. Rent or a current mortgage keeps running during the build, and property taxes and homeowners insurance come on top of the $2,710 once you move in.
Costs that don't show up in the rate
Interest is the visible cost. The items below sit in the lender's fee schedule and the builder contract instead:
Draw and inspection fees: some lenders charge each time funds are released
Second closing costs: a construction-only loan closes again at the end
Contingency reserve: a cushion for overruns, commonly built into the budget
Interest reserve: some lenders add build-phase interest to the loan
When a construction loan goes wrong
Most construction loan trouble starts with a build that costs more or runs longer than planned, not with the rate. These are the four risks to price in before you sign:
Cost overruns: the lender funds the approved budget, so extra costs are yours
Delays: every extra month adds interest and housing costs
Builder trouble: a stalled or failed builder can halt draws mid-build
Appraisal shortfall: a low as-completed value can raise your cash down
HUD's Handbook 4000.1 describes FHA's construction-to-permanent program as one mortgage closing before construction starts, and it requires a licensed general contractor. A borrower can act as the contractor only if licensed, which is one reason owner-builder loans are hard to get.
Price a late, over-budget build
Ask for the lender's overrun and extension rules in writing before you close. Then test a build that finishes three months late: that is three more interest payments of $2,667 at full draw, plus the cash to cover overruns.
Construction-to-permanent vs. two loans vs. FHA one-time close
Each option funds the same build, but they differ in closings, re-approval and the cash the lender wants up front.
Three ways to finance a home build
Construction-to-permanent vs. two loans vs. FHA one-time close
Construction-to-permanent
Construction-only, then a mortgage
FHA one-time close
Closings
One
Two: one for the build, one for the mortgage
One
Closing costs
One set
Two sets
One set
Re-qualify at completion
Usually no; the loan converts
Yes; a new mortgage approval
Usually no; the loan converts
Down payment
Commonly 20%
Commonly 20% on the build loan
From 3.5%
Credit score
Commonly 680 or higher
Commonly 680 or higher, checked again at the mortgage
FHA minimum 580; many lenders set more
Fits best
One approval and no second closing
Borrowers who want to shop the mortgage later
Smaller savings, with a licensed builder
FHA, VA and USDA one-time-close programs exist at some lenders; the FHA loan guide covers the low-down-payment route. If you still need the lot, a land loan buys it first, but you would then finance the build separately.
Who a construction loan fits
A construction loan fits buyers who want a home built to their own plans and already have the land, a vetted builder and cash for the down payment.
Landowners with finished plans and a lender-approved builder
Buyers who want a custom design, not a resale home
Borrowers with cash or land equity for the down payment
Households that can carry housing costs during the build
Skip it if an existing or newly built home would do: a standard purchase mortgage closes faster and needs no draw process. For renovating a home you own, a 203(k) loan fits better.
Construction loans: pros and cons
Pros
Lets you build the home you want on your own site
Interest only on the money actually drawn
One closing and one approval with construction-to-permanent
Land equity can often cover part of the down payment
Cons
Commonly 20% down and a 680 score
Overruns and delays come out of your pocket
Two sets of closing costs if construction-only
Rate often runs above a finished-home mortgage
What construction lenders look for
Conventional lenders commonly want 20% down, a credit score near 680 and a debt-to-income ratio up to 45%. That is stricter than many purchase loans because the collateral does not exist yet.
They also approve the project itself: your builder's license and track record, the plans and specifications, and an itemized budget. Because the appraisal values the finished home, a low appraisal can shrink the loan or raise the cash you owe at closing.
Requirements at a glance
Down payment of 20% at many conventional lenders, or 3.5% with FHA
Credit score of 680 or higher at many conventional lenders
Debt-to-income ratio up to 45%, counting the new housing payment
A licensed, lender-approved builder with a signed construction contract
Plans, specifications and an itemized budget, often with a contingency reserve
An as-completed appraisal that supports the loan amount
A construction loan pays your builder in stages, called draws, instead of one lump sum. After each stage passes inspection, the lender releases the next draw, and you pay interest only on the amount drawn so far.
When the home is finished, the loan converts to a permanent mortgage or a new loan pays it off.
Is a construction loan harder to get than a mortgage?
Yes — the lender must approve the project as well as you. It reviews your builder, plans, budget and an as-completed appraisal on top of credit and income.
Conventional lenders commonly want 20% down, a score near 680 and a debt-to-income ratio up to 45%, which is stricter than many purchase loans.
Do you need 20% down for a construction loan?
Often, yes. Conventional lenders commonly ask for 20% down because the home does not exist yet to secure the loan.
An FHA one-time-close loan allows 3.5% down at lenders that offer it, and equity in land you already own can often count toward the requirement. Ask each lender how it values the lot.
How much would a $100,000 construction loan cost per month?
Fully drawn, a $100,000 loan costs a quarter of the $2,667 our $400,000 example reaches at full draw, in interest only at an illustrative 8.00%.
The payment starts far lower, because interest runs only on what is drawn: in our $400,000 example, $80,000 drawn costs $533 a month and the full $400,000 costs $2,667. Principal payments usually begin once the home is finished.
What are the downsides of getting a construction loan?
The main downsides are stricter approval, a higher rate and risk that stays with you. Lenders commonly want 20% down, the rate often runs above a finished-home mortgage, and overruns or delays are your cost.
A construction-only loan adds a second closing, with new costs and a fresh approval.
What is the typical interest rate for a construction loan?
Construction loans usually cost more than a finished-home mortgage, and no official average exists. In our illustration, prime (7.00%) plus 1 percentage point gives 8.00%, against a Freddie Mac 30-year average of 7.18%. Your rate depends on the lender, your credit and the loan structure.
What is the difference between a construction-to-permanent and a construction-only loan?
A construction-to-permanent loan closes once and converts to a mortgage when the home is finished. A construction-only loan closes twice: a separate mortgage repays it at the end, which means a second approval and a second set of closing costs. One closing is simpler; two lets you shop the mortgage later.
Can you get an FHA construction loan?
Yes — some lenders offer FHA one-time-close loans that combine the build and the mortgage with 3.5% down. HUD's rules still apply, including a licensed general contractor for the build, and only some lenders offer the program. VA and USDA one-time-close versions also exist at some lenders.
How long does the construction phase last?
Many construction loans allow about a year to build, as in our 12-month example, though the term varies by lender and project. When the build ends, the loan converts to a permanent mortgage or must be repaid. If work runs late, ask about extension terms and fees before you sign.
What happens if the build runs over budget?
You cover the difference. The lender funds only the budget it approved, and changes to the plans usually need its sign-off. Many lenders therefore build a contingency reserve into the budget, money set aside for overruns. Ask what happens if you exceed it before you close.
This guide is general information, not a lending decision. Program rules and dollar limits change — verify current figures with a licensed lender and confirm licensing at NMLS Consumer Access. See all loan types.
Nothing matches that. Try “refinance”, “FHA”, “Texas”, “Rocket” or “PMI”.