Construction Loan Basics for Homeowners

A construction loan is short-term financing that funds the cost of building a new home or completing a major renovation. Unlike a standard mortgage that disburses one lump sum at closing, construction loans release funds in stages (called draws) tied to construction milestones. The borrower pays interest only on the funds drawn so far, which keeps payments lower during the build.

Most construction loans are 12 to 18 months long. At the end, the loan either converts to a permanent mortgage or pays off through a separate end loan, depending on the loan structure.

Construction-to-permanent loans (often called single-close or one-time-close) combine the construction loan and the permanent mortgage into a single closing. After construction is complete, the loan converts to a standard mortgage with a single set of closing costs.

Stand-alone construction loans require two closings: one for the construction loan, and a second for the permanent end loan. Two closings means two sets of closing costs and two underwriting cycles, but it can be useful if the borrower wants to shop end-loan rates after construction completes.

Most 2026 borrowers default to construction-to-permanent for the cost savings unless rate volatility makes the second-closing flexibility worth more.

Lenders typically disburse construction loan funds in 4 to 6 draws tied to construction milestones. A common schedule is foundation complete, framing complete, dried-in (roof and windows), mechanical rough-in, drywall, and substantial completion.

Before each draw releases, the lender sends an inspector to verify the milestone is actually complete. The inspector signs off, the lender releases the draw, and the funds go directly to the contractor. The borrower pays interest only on the cumulative draws to date.

Draw schedule mismatch with the contractor's payment expectations is a top cause of project delays. Match the lender's draw schedule to the contractor's payment schedule before signing the contract.

Construction loan qualification standards are tighter than standard mortgages because the lender is taking on additional risk during the build. Most 2026 lenders require a credit score of 680 or higher (700 plus for the best rates), 20 to 25% down (often as cash equity in the lot), debt-to-income ratio under 45%, and detailed construction documentation including plans, specs, contractor agreement, and a fixed budget.

The lender also reviews the appraised future value of the completed project. If the appraisal comes in low, the loan amount drops, which can force the borrower to add cash or shrink the project scope.

Lenders require contractor approval before closing because the contractor is performing the work that secures the loan. A failed or unscrupulous contractor can leave the lender holding a half-built project worth less than the loan balance.

Lender approval typically requires the contractor to provide a current license, current insurance certificates (general liability and workers' comp), recent comparable project references, and a financial profile that shows the contractor has working capital to carry the project. Some lenders publish an approved-contractor list, while others approve case-by-case.

If your preferred contractor is not on a lender's list, expect 3 to 6 weeks of additional underwriting time for case-by-case approval.

Construction loans usually include a contingency reserve (often 5 to 10% of project cost) inside the loan amount. Contingency draws require lender approval and detailed justification.

If actual costs exceed the loan amount plus contingency, the borrower must bring cash to cover the gap, get a loan modification (slow and expensive), or scope down the remaining work. Of the three, scope reduction is usually the cleanest. This is why a strong upfront budget and a 12 to 18% project-side contingency (separate from the loan-side contingency) matter so much.