How Construction Loans Work
A construction loan is short-term financing that covers the cost of building a home, released to your builder in stages as work is completed rather than as one lump sum. Because there's no finished house to serve as collateral until the build is done, lenders treat construction loans as higher risk than a standard mortgage on an existing home — which shows up in stricter credit requirements and a higher interest rate during the build phase.
Single-Close vs. Two-Close Construction Loans
Most builders today use a construction-to-permanent loan (also called a single-close loan). You close once, at the start of the project, and the loan automatically converts into a regular mortgage the moment construction wraps up — no second application, no second appraisal, no second set of closing costs.
The older alternative is a stand-alone construction loan (two-close). You take out a short-term loan just to build, then apply separately for a permanent mortgage to pay it off once the home is finished. This means qualifying twice and paying closing costs twice — which is why single-close loans have become the more common choice for most buyers.
How Draws Work
Instead of receiving your full loan amount on day one, funds are released in draws tied to construction milestones. A typical draw schedule looks like:
- Site prep & foundation — grading, excavation, footings poured
- Framing — walls and roof structure up
- Roofing & exterior — roof, siding, windows installed
- Mechanicals — plumbing, electrical, and HVAC rough-in
- Drywall & interior finishes — insulation, drywall, flooring, cabinets
- Final completion — punch list complete, certificate of occupancy issued
An inspector typically confirms each stage is finished before the lender releases the next draw — which protects both you and the lender from paying for work that hasn't actually happened yet.
Why Construction-Phase Interest Is Only an Estimate
Because your builder isn't holding the full loan amount from day one, you're not paying interest on the entire loan the whole time you're building. This calculator models a typical draw pattern: slower draws during site work, faster draws through framing and mechanicals, then tapering off at finishes. It charges interest each month only on the balance drawn so far. Real schedules vary by builder, project and lender, so ask your lender for their draw schedule to tighten the estimate.
What Lenders Look For
Beyond credit score, construction loan underwriting typically also reviews your builder's license and track record, a detailed cost breakdown and construction contract, and an appraisal based on the completed home's projected value — not the empty lot. Most lenders also require a contingency reserve, often 5–10% of the construction budget, to cover unexpected cost overruns without derailing the loan.