[Construction Loan](/blog/construction-loan-guide) Types: Complete Guide for Builders and Renovators

Construction loans provide specialized financing for building new homes, completing major renovations, or converting properties. Unlike traditional mortgages that fund completed properties, construction loans disburse funds in stages as building progresses, creating unique structures, risks, and opportunities.

Understanding the different types of construction loans, how they work, and which fits your project is essential before breaking ground. This comprehensive guide explores all major construction loan types available in 2026, helping builders, renovators, and homeowners choose the right financing for their projects.

What Are Construction Loans?

Construction loans are short-term loans (typically 6-18 months) that finance building projects from ground-up construction to major renovations. Rather than receiving all funds at closing, borrowers receive money in "draws" at specific project milestones.

Key Characteristics:

• Short-term: Usually 6-18 months (construction period)
• Draw-based funding: Money released as work progresses
• Higher interest rates: 1-3% above traditional mortgages
• [Interest-only payments](/blog/heloc-draw-period-vs-repayment): During construction period
• Construction-focused underwriting: Evaluates plans, costs, builder, and borrower
• Inspection-based draws: Funds released after verifying completed work

Major Construction Loan Types

1. Construction-to-Permanent Loans (Single-Close)

The most popular construction loan type, combining construction financing and permanent mortgage in one loan.

How It Works:

• Apply once and close once
• Construction loan during building phase (interest-only payments)
• Automatically converts to permanent mortgage when construction completes
• Lock interest rate at application (protects against rate increases)
• Single set of closing costs

Best For:

• Owner-occupied home construction
• Borrowers wanting simplicity and certainty
• Rising interest rate environments
• First-time custom home builders

Typical Terms:

• Construction phase: 12-18 months
• Interest during construction: Prime + 1-2%
• Permanent mortgage: 15 or 30-year fixed
• Down payment: 20-25%
• Loan-to-value: 80%

Advantages:

• One application and closing
• Rate locked at beginning
• Seamless transition to permanent financing
• Lower total costs than two separate loans
• Less paperwork and hassle

Disadvantages:

• Committed to one lender for both phases
• May not get best permanent mortgage rate
• Stricter qualification (must qualify for both phases)
• Less flexibility if plans change

2. Construction-Only Loans (Two-Close)

Separate financing for construction phase; requires refinancing to permanent mortgage after completion.

How It Works:

• Apply for construction loan only
• Interest-only payments during construction
• Full balance due when construction completes
• Refinance to permanent mortgage (second closing)
• Pay two sets of closing costs

Best For:

• Borrowers expecting improved financial situation
• Those wanting to shop for best permanent mortgage rate
• Investors planning to sell after construction
• Experienced builders comfortable with refinancing

Typical Terms:

• Construction phase: 6-12 months
• Interest rate: Prime + 1-3%
• Interest-only payments
• Balloon payment at end
• Down payment: 20-30%

Advantages:

• Flexibility to shop permanent mortgage rate
• Not locked to one lender long-term
• Can sell before refinancing
• Shorter commitment period

Disadvantages:

• Two closings = double closing costs
• Refinancing risk if rates rise or finances change
• More complex process
• May not qualify for permanent mortgage

3. Renovation Construction Loans (FHA 203(k), Fannie Mae HomeStyle)

Specialized loans combining purchase price and renovation costs into one mortgage.

Types:

FHA 203(k):

• Government-insured renovation loan
• Standard 203(k): Major renovations ($5,000+)
• Limited 203(k): Smaller projects (up to $35,000)
• Down payment: 3.5%
• Loan limits: Standard FHA limits by county

Fannie Mae HomeStyle:

• Conventional renovation loan
• No renovation dollar limits
• Can exceed FHA loan limits
• Down payment: 5% (owner-occupied), 15-25% (investment)
• More property types eligible

Best For:

• Purchasing fixer-uppers
• Major home renovations
• Buyers without separate cash for renovations
• Financing improvements into mortgage

Advantages:

• Low down payments (especially FHA 203(k))
• Purchase + renovation in one loan
• Qualified contractors required (quality assurance)
• Renovations increase appraised value

Disadvantages:

• Complex documentation and requirements
• Contractor must be approved by lender
• Specific renovation guidelines
• Longer closing times
• Escrow holdbacks and inspection requirements

4. Owner-Builder Construction Loans

For qualified homeowners acting as their own general contractor.

How It Works:

• Borrower serves as general contractor
• Directly manages subcontractors and project
• Lender disburses funds based on completed work
• Often requires construction experience and licenses

Best For:

• Experienced builders building own home
• Licensed contractors
• Savvy homeowners with construction background
• Those wanting maximum control

Typical Terms:

• Higher down payment: 25-30%
• Stricter qualification
• Detailed project plans required
• License and experience verification
• Loan-to-value: 75-80%

Advantages:

• Save general contractor fees (10-20%)
• Complete control over project
• Direct subcontractor relationships
• Potential cost savings

Disadvantages:

• Difficult to qualify
• Requires construction expertise
• Full liability for project success
• Time-consuming management
• Higher down payments

5. Spec Construction Loans

For builders constructing homes for sale (speculative building).

How It Works:

• Builder constructs home without specific buyer
• Short-term financing during construction
• Repaid when home sells
• May convert to permanent mortgage if builder can't sell

Best For:

• Professional builders and developers
• Experienced investors
• Builders with pre-sales or strong markets
• Development projects

Typical Terms:

• Term: 12-24 months
• Higher interest rates: Prime + 2-4%
• Higher down payment: 20-30%
• Loan-to-cost: 70-80%
• Based on builder's track record

Advantages:

• Build inventory for sale
• Capitalize on market opportunities
• Portfolio approach for multiple specs
• Experienced builders get preferential terms

Disadvantages:

• Highest risk (no guaranteed buyer)
• Higher rates and costs
• Strict qualification
• Market risk exposure
• Requires construction experience

6. Lot Acquisition and Construction Loans

Combined financing for land purchase and construction.

How It Works:

• One loan covers land purchase and construction
• Land purchase financed first
• Construction draws follow
• May convert to permanent mortgage

Best For:

• Buyers purchasing land and building simultaneously
• Those without cash to buy land outright
• Single-transaction preference

Typical Terms:

• Down payment: 20-30%
• Land loan portion starts immediately
• Construction draws begin when building starts
• Higher overall borrowing capacity needed

Advantages:

• One transaction for land and construction
• Don't need cash to purchase land
• Simplified process
• Rate lock covers both phases

Disadvantages:

• Paying interest on land before building starts
• Higher total borrowing required
• More complex qualification
• Larger down payment needed

7. Commercial Construction Loans

For commercial properties, mixed-use buildings, or investment construction.

How It Works:

• Finances construction of income-producing properties
• Based on projected property performance
• Often interest-only during construction
• May include permanent financing component

Best For:

• Commercial developers
• Mixed-use projects
• Apartment building construction
• Investment property construction

Typical Terms:

• Down payment: 25-35%
• Term: 12-36 months
• Rate: Variable, based on Prime or LIBOR
• Loan-to-cost: 65-80%
• Based on property cash flow projections

Advantages:

• Larger loan amounts
• Flexible structures
• Portfolio relationships
• Based on property economics

Disadvantages:

• Complex qualification
• Higher costs
• Requires experience
• Shorter terms
• Higher down payments

8. Hard Money Construction Loans

Short-term, asset-based construction financing from private lenders.

How It Works:

• Based primarily on property value and equity
• Minimal qualification requirements
• Fast approval (days to weeks)
• High interest rates and fees
• Short term: 6-18 months

Best For:

• Fix-and-flip investors
• Borrowers who can't qualify conventionally
• Time-sensitive projects
• Credit-challenged borrowers

Typical Terms:

• Interest rate: 9-15%+
• Points: 2-5% of loan amount
• Down payment: 20-35%
• Loan-to-cost: 65-75%
• Based on after-repair value (ARV)

Advantages:

• Fast funding
• Flexible qualification
• Asset-based (property focused)
• Credit issues less important

Disadvantages:

• Very high costs
• Short repayment periods
• Balloon payments
• Less consumer protection
• Highest total expense

How Construction Loan Draws Work

Construction loans disburse funds in stages as work progresses, protecting both borrower and lender.

Typical Draw Schedule:

Draw 1 - Foundation (20%):

• Foundation poured and cured
• Inspection confirms completion
• Funds released for foundation costs

Draw 2 - Framing (20%):

• Framing completed
• Roof structure complete
• Inspection and fund release

Draw 3 - Mechanicals (20%):

• Plumbing, electrical, HVAC rough-in
• Systems inspected
• Funds released

Draw 4 - Drywall and Insulation (15%):

• Interior walls installed
• Insulation complete
• Inspection and funding

Draw 5 - Finishes (15%):

• Flooring, cabinets, fixtures
• Interior finishes installed
• Inspection and release

Draw 6 - Final Completion (10%):

• Final walkthrough
• Punch list completed
• Certificate of occupancy
• Final draw and conversion to permanent mortgage

Inspection Process:

1. Borrower or builder requests draw
2. Lender sends inspector to verify work
3. Inspector confirms completion and quality
4. Lender releases funds (usually within 3-7 days)
5. Funds pay for completed work

Construction Loan Qualification Requirements

Credit Score

Minimum: 640-680 (varies by loan type) FHA 203(k): 620-640 Conventional construction-to-permanent: 680-700 Best terms: 720+

Down Payment

Owner-occupied: 20-25% Investment/Spec: 25-35% FHA 203(k): 3.5% Fannie Mae HomeStyle: 5% (owner-occupied)

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

Maximum: Usually 43-45% Calculation: Based on projected permanent mortgage payment Includes: All debt plus property taxes and insurance

Cash Reserves

Typical requirement: 6-12 months Purpose: Cover cost overruns and unexpected expenses Stronger reserves: Better terms and approval odds

Documentation

Personal:

• Tax returns (2 years)
• W-2s or business tax returns
• Pay stubs (recent 30-60 days)
• Bank statements (2-3 months)
• Asset documentation

Project:

• Detailed construction plans and specifications
• Itemized budget and cost breakdown
• Building permits
• Builder contracts
• Builder credentials and insurance
• Timeline estimates

Builder Requirements

Licensed and insured:

• General contractor license
• Liability insurance
• Worker's compensation insurance
• Builder's risk insurance

Experience:

• Proven track record
• References from previous projects
• Financial stability
• Portfolio of completed work

Construction Loan Costs

Interest Rates

Construction phase:

• Construction-to-permanent: Prime + 1-2% (currently ~9-10%)
• Construction-only: Prime + 1-3% (currently ~9-11%)
• Hard money: 9-15%+

Permanent phase:

• Current conventional rates (~7-8%)
• Locked at application for construction-to-permanent

Fees

Origination fee: 1-2% of loan amount Processing/Underwriting: $500-$1,500 Inspection fees: $200-$500 per draw (5-6 draws typical) Appraisal: $500-$1,000 Title insurance: $1,000-$3,000 Closing costs: 2-5% of loan amount

Example Total Costs:

$500,000 construction-to-permanent loan:

• Origination (1.5%): $7,500
• Closing costs: $3,500
• Inspection fees (6 draws): $2,400
• Interest during construction (12 months, interest-only): $45,000
• Total construction phase cost: $58,400

After conversion to permanent mortgage, normal mortgage payments begin.

Choosing the Right Construction Loan Type

Choose Construction-to-Permanent When:

• Building owner-occupied home
• Want simplicity and rate certainty
• Comfortable with one lender
• Planning to keep the home long-term
• First-time custom home builder

Choose Construction-Only When:

• Planning to sell after construction
• Want flexibility to shop permanent mortgage
• Expect improved finances during construction
• Experienced with construction lending
• Comfortable with refinancing risk

Choose [Renovation Loans](/blog/dscr-loan-fix-and-flip) When:

• Purchasing fixer-upper
• Need to finance purchase and renovations together
• Limited cash for separate renovation budget
• Want lower down payments (FHA 203(k))

Choose Owner-Builder When:

• Licensed contractor or experienced builder
• Want to save GC fees
• Have time to manage project
• Can qualify with higher down payment

Choose Spec Construction When:

• Professional builder building for sale
• Building speculative inventory
• Experienced in construction and sales
• Have market knowledge and exit strategy

Choose Hard Money When:

• Can't qualify conventionally
• Need very fast funding
• Fix-and-flip project
• Short-term need with clear exit strategy

Related Articles

• Construction Loan Guide
• [Balloon Mortgage Explained](/blog/balloon-mortgage-explained)
• Bridge Loan For Real Estate
• [Real Estate Leverage Explained: How to Use Other People's Money to Build Wealth](/blog/real-estate-leverage-explained)

Frequently Asked Questions

How long does it take to get approved for a construction loan?

Typically 30-60 days due to the complexity of reviewing plans, budgets, builder qualifications, and borrower financials. Simpler projects or experienced builders may close faster; complex projects may take longer.

Can I act as my own general contractor?

Possible but difficult. Most lenders require professional licensed general contractors. Owner-builder construction loans exist but require construction experience, licenses, higher down payments, and stricter qualification.

What happens if construction costs exceed the budget?

Borrowers must cover overruns out of pocket. This is why lenders require substantial cash reserves (6-12 months). Having a contingency fund (10-15% of budget) is essential for unexpected costs.

Can I make changes to plans after loan approval?

Minor changes are usually acceptable; major changes may require lender re-approval and could affect loan amount. Discuss all changes with your lender before implementing them.

What if I can't complete construction in the allowed time?

Most lenders allow extensions (typically 3-6 months) for fees and possibly higher interest rates. Communicate early with your lender if delays are anticipated.

Do I make monthly payments during construction?

Usually interest-only payments on funds disbursed so far. Some lenders offer deferred interest (added to loan balance). After construction completes, [principal and interest](/blog/amortization-schedule-guide) payments begin.

Can I get a construction loan with bad credit?

Difficult but possible. Minimum credit scores are typically 640-680 for conventional construction loans. Hard money lenders may work with lower scores but charge much higher rates.

[How much equity do I need](/blog/home-equity-milestones) in my land?

For construction-only loans (land already owned), typically 20-30% equity minimum. Combined lot-and-construction loans may require 20-25% down payment on the combined project cost.

Conclusion

Construction loans offer specialized financing for building dreams—whether ground-up custom homes, major renovations, or investment projects. Understanding the different construction loan types and choosing the right one for your situation is crucial for project success.

Key factors in selecting construction loan type:

• Project type: New construction vs. renovation vs. spec
• Experience level: First-time builder vs. professional
• Financial situation: Down payment, reserves, credit, income
• Timeline: How long you'll keep the property
• Risk tolerance: Interest rate risk, refinancing risk, market risk

Success with construction financing requires:

• Detailed planning: Comprehensive budgets and timelines
• Strong team: Qualified builder, architect, professionals
• Adequate reserves: Budget for overruns and delays
• Clear communication: With lender throughout process
• Realistic expectations: Construction projects face delays and surprises

At HonestCasa, we work with builders, renovators, and homeowners navigating construction financing, from owner-occupied builds to investment projects. Whether you're building your dream home or developing spec properties, we can help you explore construction loan options and find the right fit for your project. Contact us to discuss your construction financing needs.