Construction Loan Guide 2026: How to Finance Building Your Dream Home

Building a custom home offers the ultimate in personalization and control, but financing new construction differs dramatically from purchasing an existing home. Construction loans provide the specialized funding structure needed to pay builders progressively as your home takes shape, converting to permanent financing once construction completes.

In 2026, understanding construction loans—from draw schedules to qualification requirements—is essential for anyone considering building their dream home from the ground up.

What Is a Construction Loan?

A construction loan is a short-term financing product (typically 6-18 months) that provides funds in stages as construction progresses. Unlike traditional mortgages that disburse the full amount at closing, construction loans release money incrementally based on completed work, protecting both the lender and borrower.

How Construction Loans Differ from Traditional Mortgages

Traditional mortgage:

• Lump sum disbursed at closing
• Monthly [principal and interest](/blog/amortization-schedule-guide) payments
• 15-30 year terms
• Secured by finished property

Construction loan:

• Funds released in draws as construction progresses
• [Interest-only payments](/blog/heloc-draw-period-vs-repayment) on borrowed amount
• 6-18 month term
• Secured by land and partially completed improvements
• Higher rates due to increased risk
• Requires detailed construction plans and budgets

Types of Construction Loans

[Construction-to-Permanent Loan](/blog/construction-loan-types) (Single-Close)

The most popular option, combining construction and permanent financing:

How it works:

• One application, one closing, one set of fees
• Construction loan automatically converts to permanent mortgage when building completes
• Lock in permanent mortgage rate at beginning
• Interest-only payments during construction
• Full principal and interest payments after conversion

Advantages:

• Single closing saves thousands in fees
• Rate protection if rates rise during construction
• Simpler process with one lender
• Seamless transition to permanent financing

Disadvantages:

• If rates drop during construction, you're locked into higher rate (unless you refinance)
• Some lenders charge slightly higher rates for the convenience
• Less flexibility to change lenders post-construction

Current rates (February 2026):

• Construction phase: 7.50% - 8.50% (interest-only)
• Permanent phase: 6.75% - 7.50% (principal + interest)

Construction-Only Loan (Two-Close)

Separate loans for construction and permanent financing:

How it works:

• Construction loan for building phase (6-18 months)
• Pay off construction loan when complete
• Apply for permanent mortgage separately
• Two applications, two closings, two sets of fees

Advantages:

• Flexibility to shop for permanent mortgage later
• Can benefit if rates drop during construction
• May find better permanent mortgage terms
• Useful if building speculatively

Disadvantages:

• Pay closing costs twice ($6,000-$12,000+ extra)
• Risk of not qualifying for permanent mortgage
• Interest rate uncertainty for permanent loan
• More complex with two separate processes

Current rates (February 2026):

• Construction phase: 8.00% - 9.50%

Owner-Builder Construction Loan

For borrowers acting as their own general contractor:

How it works:

• You manage all subcontractors and construction
• More scrutiny from lenders
• Often requires construction experience
• May need to show contractor licenses or experience

Advantages:

• Save on general contractor fees (15-25%)
• Complete control over project
• Choose all subcontractors and materials

Disadvantages:

• Much harder to qualify (many lenders won't offer)
• Requires significant construction knowledge
• Time-intensive management responsibility
• Higher risk of cost overruns and delays
• Higher rates (typically 1-2% premium)

Current rates (February 2026):

• 9.00% - 11.00%+

Renovation Construction Loan

For major renovations requiring construction financing:

How it works:

• Finance extensive renovations (not minor repairs)
• Based on after-[renovation value](/blog/renovation-roi-by-project)
• Funds released as renovation milestones complete

Common programs:

• FHA 203(k) - Government-backed [renovation loans](/blog/dscr-loan-fix-and-flip)
• Fannie Mae HomeStyle Renovation
• Conventional renovation loans

How Construction Loan Draw Schedules Work

Construction loans release funds in stages called "draws" tied to construction milestones:

Typical Draw Schedule (5-7 draws)

Draw 1: Land/Foundation (15-20%)

• Land purchase (if not already owned)
• Site preparation and excavation
• Foundation and footings complete
• Inspection: Foundation passes code

Draw 2: Framing (20-25%)

• Framing complete (walls, roof structure)
• Windows and exterior doors installed
• Roof sheathing complete
• Inspection: Framing passes code

Draw 3: Mechanical Rough-In (15-20%)

• Plumbing rough-in complete
• Electrical rough-in complete
• HVAC installation
• Inspection: Rough-ins pass code

Draw 4: Insulation and Drywall (15-20%)

• Insulation installed
• Drywall hung and finished
• Inspection: Insulation passes code

Draw 5: Interior Finishes (15-20%)

• Interior painting complete
• Cabinets and countertops installed
• Flooring installed
• Interior trim and doors

Draw 6: Final Completion (10-15%)

• Fixtures installed (lighting, plumbing)
• Appliances installed
• Exterior landscaping
• Final punch list items
• Certificate of occupancy received

Draw Request Process

1. Contractor requests draw: Submits documentation of completed work
2. Lender inspection: Third-party inspector verifies completion
3. Lender approval: Reviews and approves draw request
4. Fund disbursement: Releases funds (to contractor or borrower)
5. Timeline: Typically 5-10 business days from request to funding

Important: Most lenders hold back 10% of each draw as "retainage" until final completion to ensure quality and project finish.

Construction Loan Qualification Requirements

Construction loans require more stringent qualifications than traditional mortgages:

Credit Score

• Minimum: 680 (some lenders 660)
• Preferred: 700+
• Best rates: 740+
• Owner-builder: Often 720+ required

Down Payment

• Minimum: 20% (some lenders require 25%)
• Preferred: 25-30%
• Land equity: If you own land, equity counts toward down payment
• Owner-builder: Often 25-30% minimum

Example: Building a $500,000 home

• 20% down payment: $100,000
• If you own $150,000 land free and clear: Counts as $150,000 down payment (30%)

[Debt-to-Income Ratio](/blog/dti-ratio-explained)

• Maximum: 43% (some lenders 45%)
• Calculation: Based on future permanent mortgage payment, not construction loan interest
• Includes: All existing debts plus new mortgage payment

Cash Reserves

• Minimum: 6 months of mortgage payments
• Preferred: 12+ months
• Purpose: Cover cost overruns and construction delays

Example: $500,000 build with future $3,500 monthly payment

• Minimum reserves: $21,000
• Preferred reserves: $42,000+

Detailed Construction Plans

Lenders require comprehensive documentation:

• Architectural plans: Complete blueprints
• Specifications: Detailed materials and finish schedule
• Itemized budget: Line-item construction costs
• Builder contract: Signed agreement with licensed contractor
• Timeline: Realistic construction schedule
• Permits: Building permits obtained or applied for

Licensed General Contractor

• Must use licensed, insured contractor (owner-builder exception)
• Lender vets contractor's experience and reputation
• Contractor provides proof of insurance
• Payment typically goes directly to contractor

[Property Appraisal](/blog/appraisal-process-explained)

• As-is appraisal: Current land value
• Subject-to-completion appraisal: Projected value when complete
• Loan amount: Based on lower of cost or appraised value

Example:

• Construction cost + land: $550,000
• Appraised complete value: $600,000
• Loan basis: $550,000 (cost is lower)

Construction Loan Costs and Fees

Construction loans involve more fees than traditional mortgages:

Origination Fees

• 1% - 2% of loan amount
• Example: $400,000 loan = $4,000 - $8,000

Application Fees

• $500 - $1,500

Appraisal Fees

• $500 - $1,000 (more complex than standard appraisals)

Inspection Fees

• $300 - $600 per draw inspection
• Typically 5-7 inspections = $1,500 - $4,200 total

Draw Fees

• $100 - $300 per draw
• 5-7 draws = $500 - $2,100 total

Permanent Conversion Fee (construction-to-permanent)

• $500 - $1,000

Survey Fees

• $400 - $800

[Title Insurance](/blog/title-search-explained) and Closing Costs

• Similar to traditional mortgages
• $3,000 - $6,000

Total fees example for $400,000 construction loan:

• Origination (1.5%): $6,000
• Appraisal: $750
• Inspections: $3,000
• Draw fees: $1,200
• Other closing costs: $4,500
• Total: $15,450 (3.9% of loan)

Current Construction Loan Rates (February 2026)

Construction-to-Permanent Loans

• During construction: 7.50% - 8.50% interest-only
• After conversion: 6.75% - 7.50% principal + interest
• Term: 30-year permanent mortgage

Construction-Only Loans

• Rate: 8.00% - 9.50% interest-only
• Term: 12-18 months

Owner-Builder Loans

• Rate: 9.00% - 11.00%+ interest-only
• Term: 12-18 months

Rates vary significantly based on:

• Credit score (each 20 points ≈ 0.25% rate difference)
• Down payment (30% vs. 20% ≈ 0.25-0.50% savings)
• Builder reputation and experience
• Property location
• Loan-to-value ratio

Payment Examples During Construction

Understanding your payments during the construction phase:

$400,000 loan at 8.00% interest-only

After each draw, your payment increases:

• After draw 1 ($80,000 disbursed): $533/month interest
• After draw 2 ($160,000 disbursed): $1,067/month interest
• After draw 3 ($240,000 disbursed): $1,600/month interest
• After draw 4 ($320,000 disbursed): $2,133/month interest
• After draw 5 ($360,000 disbursed): $2,400/month interest
• After draw 6 ($400,000 disbursed): $2,667/month interest

After conversion to permanent mortgage:

• Principal + interest at 7.00%, 30 years: $2,661/month
• Payment barely changes, but now includes principal reduction

Advantages of Construction Loans

1. Build Custom Home

• Design exactly what you want
• Choose all materials and finishes
• Optimize layout for your lifestyle
• New construction with modern systems and efficiency

2. Interest-Only During Construction

• Lower payments while building
• Pay interest only on disbursed amounts
• Free up cash for construction costs

3. Single-Close Convenience

With construction-to-permanent loans:

• One application process
• One set of closing costs
• Rate lock for permanent mortgage
• Seamless transition

4. Built-In Equity

Often build equity immediately:

• Construction cost + land: $500,000
• Appraised value when complete: $575,000
• Instant equity: $75,000

5. New Home Benefits

• Everything is brand new (no repairs for years)
• Modern energy efficiency (lower utilities)
• Warranty coverage on everything
• No surprises or hidden issues

Disadvantages and Risks

1. Higher Rates and Fees

• Construction rates 1-2% above traditional mortgages
• More extensive fees (inspections, draws)
• Cost typically $10,000-$20,000+ more than buying existing

2. Complex Qualification

• Stricter requirements than traditional loans
• More documentation needed
• Longer approval process (30-60 days)

3. Construction Risks

• Cost overruns (average 10-20% over budget)
• Timeline delays (average 2-4 months longer than planned)
• Builder issues (quality, bankruptcy, disputes)
• Weather delays

4. Market Risk

• Values may decline during construction
• Could be underwater if market drops significantly
• Hard to sell partially completed homes

5. Stress and Time

• Requires active involvement and decisions
• Delays and issues create stress
• Construction takes 6-18 months vs. 30-60 days to buy existing

Cost Overrun Protection

Most construction projects exceed initial budgets. Protect yourself:

1. Build 10-20% Budget Cushion

Add contingency to your budget:

• $400,000 project budget
• Add 15% cushion: $60,000
• Total budget: $460,000

2. Get Fixed-Price Contract

• Contractor guarantees maximum price
• You're protected from cost increases
• Typically costs 5-10% premium
• Worth it for certainty

3. Detailed Specifications

• Specify exact materials and finishes
• Reduces "allowance" ambiguity
• Prevents costly change orders

4. Maintain Reserves

• Keep 20-30% of budget in accessible cash
• Don't assume construction loan covers everything
• Some costs (landscaping, window treatments) may be extra

5. Expect Delays

• Plan for 20% longer timeline
• Don't commit to move-in dates too early
• Delays = higher interest costs

Finding the Right Construction Lender

Not all lenders offer construction loans. Look for:

Local and Regional Banks

• Most common construction loan source
• Familiar with local builders and costs
• Relationship-based lending
• May offer better terms for existing customers

Credit Unions

• Member-focused service
• Often competitive rates
• May have construction expertise
• Limited to members

National Lenders

• Some offer construction-to-permanent programs
• Standardized underwriting
• May be less flexible than local banks

Builder Relationships

• Reputable builders often have preferred lender relationships
• May offer streamlined processes
• Sometimes get better terms through volume

Frequently Asked Questions

How long does construction loan approval take?

Construction loan approval typically takes 30-60 days, longer than traditional mortgages due to additional documentation review (plans, budgets, contractor vetting, appraisals). Start the process early—ideally before finalizing builder contracts.

Can I act as my own general contractor?

Yes, through owner-builder construction loans, but they're harder to qualify for, have higher rates (9-11%), require construction experience, and many lenders don't offer them. You'll need to demonstrate competence through past projects or contractor licenses.

What happens if construction costs exceed the loan amount?

You must pay cost overruns out of pocket. If you budgeted $450,000 but costs hit $480,000, you need to provide the extra $30,000. This is why 10-20% budget cushions and adequate reserves are critical.

Can I lock my interest rate during construction?

With construction-to-permanent loans, yes—you lock the permanent mortgage rate at closing. The construction phase rate is also locked. If rates drop during construction, you may be able to pay a fee to re-lock lower or refinance after conversion.

What if my builder goes out of business during construction?

This is a serious risk. Your construction loan contract should address builder default. You may need to hire a new builder to complete, potentially costing more. Thoroughly vet builders before starting and ensure they're bonded and insured.

Do I need to own the land before getting a construction loan?

Not necessarily. Many construction loans include land purchase in the first draw. However, owning land free and clear strengthens your application and can count as your down payment, making qualification easier.

Can I do some work myself to save money?

Some lenders allow "sweat equity" where you perform certain tasks yourself (painting, landscaping). This can reduce costs but requires lender approval. Major structural work must be done by licensed professionals.

How long does construction typically take?

A typical 2,000-2,500 sq ft single-family home takes 6-12 months to build under normal conditions. Complex designs, larger homes, custom features, weather delays, and permit issues can extend timelines to 12-18 months. Budget for longer than promised.

What happens if the house doesn't appraise for the expected value?

If the subject-to-completion appraisal comes in low, your loan amount will be reduced to match the lower value. You'll need to either: increase your down payment, reduce construction scope/costs, or cancel the project. This is why realistic budgets and conservative appraisals are important.

Can I make changes during construction?

Yes, through "change orders," but they're expensive. Lenders must approve changes that affect budget or timeline. Changes typically cost 20-50% more than if included originally. Finalize all decisions before construction starts whenever possible.

Is Building With a Construction Loan Right for You?

Construction loans enable custom home building but require financial strength, patience, and involvement. Consider building if you:

Should consider building:

• Want a truly custom home unavailable in existing market
• Have strong financials (20%+ down, 700+ credit, ample reserves)
• Can handle 6-18 month timelines and potential delays
• Have time to manage construction process
• Can afford 10-20% budget overruns
• Enjoy the design and building process

Should buy existing instead:

• Want to move quickly (within 60-90 days)
• Have tight budget constraints
• Lack substantial reserves for overruns
• Don't want construction involvement and stress
• Can find existing homes meeting your needs
• Prefer predictable costs and timelines

Next Steps: Start Your Custom Home Journey

Building your dream home from the ground up is an exciting journey that requires careful planning, strong financial preparation, and the right construction loan structure. Whether you choose a construction-to-permanent loan for convenience or construction-only for flexibility depends on your specific situation and goals.

Ready to explore construction financing options and bring your custom home vision to life? Get started today to speak with a construction loan specialist who can evaluate your plans, explain your financing options, and guide you through every step of the process—from initial qualification through the final certificate of occupancy.

Your custom dream home awaits—let's build the financial foundation to make it a reality.

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