Building a home requires a different kind of financing than buying one. You can't get a standard mortgage for a home that doesn't exist yet. Construction loans are specifically designed for this situation — but they work very differently from traditional mortgages, come with higher rates, and have requirements that many borrowers aren't prepared for.
This guide explains exactly how construction loans work in 2026, what they cost, what you need to qualify, and the key decisions you'll make along the way.
A construction loan is a short-term loan that provides funds to build a home. Unlike a mortgage — which gives you the full loan amount at closing — a construction loan disburses funds in stages called "draws" as construction progresses.
The draw schedule: A typical construction loan has 4–6 draws, triggered by construction milestones: - Draw 1: Foundation complete (typically 10–15% of loan) - Draw 2: Framing and roof complete (typically 20–25%) - Draw 3: MEP rough-in complete (typically 20%) - Draw 4: Drywall and exterior complete (typically 20%) - Draw 5: Substantial completion (typically 15%) - Final draw: Certificate of occupancy (typically 5–10%)
Interest during construction: You only pay interest on the amount drawn, not the total loan amount. This is called "interest-only" during construction. If you've drawn $150,000 of a $350,000 loan, you pay interest on $150,000.
Conversion to permanent mortgage: After construction is complete, the construction loan must be paid off. You do this by either refinancing into a standard mortgage (two-loan approach) or by using a construction-to-permanent loan that automatically converts.
Construction loan rates in 2026 are higher than standard mortgage rates because they carry more risk for the lender:
Current construction loan rates (May 2026): - Construction-to-permanent loans: 7.25%–8.75% - Stand-alone construction loans (requiring separate permanent mortgage): 7.75%–9.25% - Portfolio construction loans (local banks): 7.0%–8.5%
Why construction loans cost more: - Higher risk (no completed collateral during construction) - Administrative complexity (managing draws, inspections) - Shorter term (typically 6–18 months) - More lender oversight required
Total interest cost during construction: For a $350,000 construction loan at 8.0%, drawing down $35,000–$50,000/month over 10 months, total construction interest runs approximately $14,000–$22,000. This is a real project cost to budget for.
Lender fees: Construction loan origination fees: 1–2% of loan amount Draw inspection fees: $100–$300 per draw Total upfront fees on a $350,000 loan: $3,500–$10,000
Construction loans have stricter qualification requirements than standard mortgages. Here's what lenders require:
Credit score: Most construction lenders require a minimum 680 credit score. 720+ gets you better rates. Below 680, options narrow significantly.
Down payment: Construction loans typically require 20–25% down. Some lenders offer 10–15% down with private mortgage insurance (PMI), but 20% is the standard. Note: your "down payment" includes land equity if you already own the lot.
Debt-to-income ratio: Most lenders want your total debt payments (including estimated mortgage payment on the completed home) to be no more than 43–45% of your gross monthly income.
Builder approval: This is where many borrowers are surprised: the lender must approve your builder, not just you. They'll review the builder's license, insurance, financial stability, and in some cases, completed project history. Owner-builder projects are possible but fewer lenders offer them.
Detailed plans and specifications: You'll need complete architectural plans, specifications, and a signed construction contract with your builder before the loan closes. The lender needs to know exactly what they're financing.
Appraiser's "as-completed" value: The lender will have an appraiser estimate the home's value upon completion. The loan-to-value ratio is based on this appraisal — if the appraised value is lower than expected, the loan amount may be reduced.
Construction-to-permanent loan (C2P / one-time close): You close once, locking in your permanent mortgage rate upfront. The loan automatically converts to a mortgage when construction is complete.
Advantages: One set of closing costs. Rate certainty — you know your permanent rate before you break ground. Simpler process.
Disadvantages: You're locking a rate 6–12+ months before you need it. If rates drop during construction, you're stuck with the higher rate. Slightly higher rates than stand-alone construction loans.
Stand-alone construction loan (two-time close): You get a construction loan first, then refinance into a permanent mortgage when the home is complete.
Advantages: Flexibility to shop for the best permanent mortgage rate when construction ends. Can take advantage of rate decreases during construction.
Disadvantages: Two closings = two sets of closing costs ($3,000–$8,000 extra). Rate risk — if rates rise during construction, your permanent mortgage will be at the higher rate.
Which is right for 2026? In the current rate environment with moderate rate uncertainty, construction-to-permanent makes sense for most borrowers. The rate certainty and single closing simplicity outweigh the flexibility benefit for most people. If you believe rates will drop significantly during your 10–12 month build, stand-alone gives you the option to capture that.
Shop multiple lenders. Local community banks and credit unions often offer better construction loan terms than large national banks. They keep these loans in their own portfolio rather than selling them, which gives them more flexibility on rate and underwriting.
Have complete plans ready. Lenders process construction loans faster when plans are complete and detailed. Incomplete submissions cause delays that cost you time and money.
Negotiate the draw schedule. A draw schedule that aligns with your builder's actual payment needs reduces the total interest you pay during construction. Fewer, larger draws can reduce inspection fees.
Consider an owner-builder loan. If you're qualified to act as owner-builder, owner-builder construction loans exist — but they're harder to find (fewer than 20% of lenders offer them) and typically require more documentation.
Line up permanent financing early. If using a stand-alone construction loan, have your permanent mortgage lender selected before construction starts. A slow or problematic permanent mortgage application at the end of construction creates expensive delays.
Maintain 20% equity cushion. Construction cost overruns happen. Maintaining a 20% budget contingency ensures you won't need to go back to the lender for additional funds — which is expensive and time-consuming.