How a Construction Loan Works — The Basics
A construction loan is a short-term loan that funds a home build in stages. Unlike a mortgage — which provides the full purchase price at closing — a construction loan releases funds in draws as construction milestones are completed and verified by a lender-appointed inspector.
During construction, you pay interest only on the amount drawn — not on the full loan. As more draws are taken, your monthly interest payment increases. Once the home is complete and a Certificate of Occupancy is issued, the loan either converts to a permanent mortgage or you refinance into a new loan.
Construction Loan Types — Which Is Right for You?
Single loan that starts as a construction loan and automatically converts to a standard mortgage when the home is complete. One closing saves $3,000 to $5,000 in closing costs vs two separate loans. Rate is locked at closing for both phases. Best for most borrowers.
Short-term loan (12 to 18 months) that covers only the construction phase. When the home is complete, you take out a separate permanent mortgage. Two sets of closing costs but allows you to shop for the best permanent mortgage rate at completion. Higher construction rate.
FHA-insured construction-to-permanent loan with a 3.5 percent down payment for borrowers with 580+ credit scores. More complex qualification process and requires FHA-approved builder. Best for buyers who cannot meet the 20 percent down requirement of conventional loans.
Zero-down construction-to-permanent loan for eligible veterans and active military. Competitive rates and no private mortgage insurance (PMI). Requires VA-approved builder and appraisal. Fewer lenders offer VA construction loans than conventional — allow extra time to find a participating lender.
Full Cost Estimate Report — $19.99
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The Construction Loan Draw Schedule
Funds are released in 5 to 7 draws tied to verified construction milestones. A lender-appointed inspector must confirm each milestone before the next draw is released. Delays in inspection scheduling are a common source of construction timeline problems.
| Draw | % of Loan | Trigger | Example Amount |
|---|---|---|---|
| Draw 1 — Site Work Complete | 10–15% | Foundation poured and inspected | $40K–$60K on $400K build |
| Draw 2 — Framing Complete | 20–25% | Framing and roof sheathing inspected | $80K–$100K |
| Draw 3 — Rough MEP Complete | 20–25% | Plumbing, electrical, HVAC rough-in inspected | $80K–$100K |
| Draw 4 — Insulation and Drywall | 15–20% | Insulation inspected; drywall installed | $60K–$80K |
| Draw 5 — Interior Finishes | 15–20% | Cabinets, flooring, fixtures installed | $60K–$80K |
| Draw 6 — Certificate of Occupancy | 10–15% | Final inspection passed; CO issued | $40K–$60K |
Draw schedule percentages are approximate and vary by lender. Inspection turnaround is typically 3 to 5 business days. Plan for this in your construction timeline.
Construction Loan Requirements Checklist
Lenders evaluate six core factors before approving a construction loan. Having all documentation ready before applying reduces approval time from 6 to 8 weeks to 3 to 4 weeks.
Higher scores get lower rates and lower down payment requirements. Below 680, most conventional lenders will decline.
Land equity counts. If you own the lot outright, its appraised value reduces your required cash down payment dollar-for-dollar.
Lender must approve plans before funding. Incomplete or sketch plans will delay approval by 4 to 8 weeks.
Most lenders maintain approved builder lists or will vet your GC. Owner-builder loans exist but fewer than 20% of lenders offer them.
Lender orders an appraisal of the home as if already built based on your plans and local comps. Loan is sized based on this value.
Calculated on your current income and debts. During construction you pay interest only on drawn funds, which is lower than full mortgage payments.
Related Tools and Guides
Full build cost — required by most lenders — $19.99
→Custom Home Cost GuideWhat your home will cost by tier and state
→Construction Cost BreakdownEvery trade category with real dollar amounts
→Hidden Costs GuideBudget items not in your builder quote
→GC Fee GuideWhat to budget for contractor management fees
→Permit CalculatorEstimate permit costs before applying
→Frequently Asked Questions
How does a construction loan work in 2026?
A construction loan provides funds in stages (called draws) as construction milestones are completed — not as a lump sum upfront. During construction, you pay interest only on the amount drawn. A lender-appointed inspector verifies each milestone before releasing the next draw. Construction loan rates in 2026 run 7 to 9 percent, which is 1 to 2 percentage points above conventional mortgage rates. Most construction loans run 12 to 18 months. When construction is complete, the loan either converts to a permanent mortgage (construction-to-permanent) or you refinance into a new loan.
What are construction loan rates in 2026?
Construction loan rates in May 2026 range from 7.25 to 9.25 percent depending on loan type, lender, and borrower qualifications. Construction-to-permanent loans run 7.25 to 8.75 percent. Stand-alone construction loans run 7.75 to 9.25 percent. VA construction loans are the most competitive at 6.5 to 8.0 percent for qualifying veterans. These rates are 1 to 2 percentage points above conventional mortgage rates (currently 6.5 to 7.0 percent) because lenders carry additional risk on an unfinished property.
How much down payment is required for a construction loan?
Most conventional construction loans require 20 to 25 percent down payment based on total project cost — land plus construction. For a $500,000 total project ($100,000 land plus $400,000 construction), expect to put down $100,000 to $125,000 in cash. If you already own the land, its appraised equity counts toward your down payment. FHA construction loans require only 3.5 percent down with a 580+ credit score. VA construction loans require zero down for qualifying veterans.
What credit score do I need for a construction loan?
Most conventional construction loans require a minimum credit score of 680. Borrowers with 700 or higher qualify for better rates and lower down payment options. Borrowers with 740 or higher get the best rates and terms. FHA construction loans accept scores as low as 580 with 3.5 percent down. VA construction loans generally require 620 or higher. If your score is below 680, focus on improving it before applying — each 20-point improvement can reduce your rate by 0.25 to 0.5 percent.
What is the difference between a construction loan and a mortgage?
A standard mortgage finances the purchase of an existing home. A construction loan finances the building of a new home. Key differences: construction loans disburse funds in draws rather than a lump sum; you pay interest only during construction; rates are 1 to 2 percent higher; terms are short (12 to 18 months); and approval requires plans, a licensed builder, and an as-completed appraisal rather than just a purchase agreement. A construction-to-permanent loan combines both — it starts as a construction loan and converts to a mortgage when building is complete.
Can I use my land as a down payment for a construction loan?
Yes. If you already own the land, its appraised value counts as equity toward your construction loan down payment. For example, if your lot is appraised at $100,000 and your total project cost (land plus construction) is $500,000, that $100,000 land equity covers the 20 percent down payment requirement — potentially eliminating the need for additional cash. The lender will order an independent appraisal of the land. Land with a remaining mortgage has only its equity (appraised value minus loan balance) applied toward the down payment.
Lenders require a detailed cost estimate to approve your loan
Get Your Build Cost Estimate Before You Apply
Most construction lenders require a detailed line-item cost estimate as part of the application. Our Cost Estimate Report gives you a professional, state-adjusted PDF breakdown that satisfies this requirement.
Get My Cost Estimate →Full report $19.99 · Instant PDF · All 50 states · Lender-ready format