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New Construction Mortgage Process

New construction mortgages encompass construction-to-permanent (CTP) loans, one-time-close and two-time-close structures, and standard purchase financing for completed spec homes. Construction lending involves staged draw disbursements tied to build milestones, interest reserves covering construction-phase payments, subject-to-completion appraisals based on plans and specifications, lender-approved builder qualification requirements, and extended rate lock strategies with float-down options that differ fundamentally from existing-home purchase financing.

Key Takeaways

  • Construction-to-permanent (CTP) loans cover both the building phase and the permanent mortgage in a single instrument, with draws disbursed as construction milestones are completed.
  • One-time-close loans eliminate duplicate closing costs (typically saving $2,000-$5,000+) but may carry slightly higher rates than separately shopped permanent financing .
  • Two-time-close structures offer more flexibility to shop permanent loan terms at completion but expose borrowers to interest rate risk and double closing costs.
  • Spec homes that are complete or near-complete at contract can be financed with standard purchase mortgages, avoiding construction loan complexity entirely.
  • Extended rate locks for new construction (180-360 days) carry premium pricing, and lock extensions add incremental cost if construction timelines slip.
  • Subject-to-completion appraisals estimate value based on plans and specifications; a final inspection or updated appraisal is required to confirm the completed home matches the original valuation basis.
  • Lenders underwrite the builder as part of construction loan approval, requiring licensing, insurance, financial stability, and a demonstrated track record of completed projects.
  • A certificate of occupancy must be issued before a CTP loan converts to permanent financing, making final building inspections a critical-path milestone.

How It Works

Timeline of a One-Time-Close CTP Loan

The process begins when the borrower applies for a CTP loan, submitting standard mortgage documentation (income, assets, credit) along with construction-specific documents including the building contract, plans and specifications, builder qualifications, and lot information. The lender underwrites both the borrower and the construction project simultaneously.

Once approved, the borrower closes the loan. At closing, the construction loan is funded (or the credit facility is established), and the permanent loan terms are documented. Construction begins, and the lender disburses funds through the draw schedule as milestones are completed and inspections are passed. During construction, the borrower pays interest only on disbursed amounts, either out of pocket or from an interest reserve.

When the home is complete and the certificate of occupancy is issued, the lender orders a final inspection or appraisal completion certification. Once the final appraisal confirms the home was built according to specifications and the value supports the loan amount, the loan converts to the permanent amortizing mortgage. The borrower begins making full principal-and-interest payments. No second closing, no additional title work, and no new underwriting are required.

How the Draw Process Works

The draw process is the mechanism by which construction funds flow from the lender to the builder. The builder completes a phase of work, submits a draw request to the lender, and the lender dispatches an inspector to verify completion. Upon satisfactory inspection and receipt of lien waivers, the lender releases the draw amount. The cycle repeats for each construction milestone.

Typical draw milestones follow the natural progression of home construction: site work and foundation, framing and roofing, mechanical rough-in (electrical, plumbing, HVAC), insulation and drywall, and final finishes and landscaping. Each draw represents a percentage of the total construction budget. Contingency reserves of 5-10% of the construction budget are common to cover change orders and unexpected costs .

The lender retains a holdback (often 10% of each draw) until final completion to ensure the builder completes all punch-list items and the home passes final inspection. This retainage is released with the final draw upon issuance of the certificate of occupancy and the appraiser’s completion certification.

How Subject-to-Completion Appraisals Differ from Standard Appraisals

A standard appraisal values a property as it exists at the time of inspection. A subject-to-completion appraisal values the property as it will exist upon completion of proposed construction. The appraiser reviews the architectural plans, specifications, and construction contract to understand the scope, quality, and features of the proposed home. Comparable sales of similar completed homes in the area provide the market data for the valuation.

The appraiser must note that the appraisal is made subject to the satisfactory completion of improvements as described in the plans and specifications. This conditional nature means the appraised value is contingent on the home being built as proposed. Material deviations from the plans, downgrading of finishes, or omission of planned features could invalidate the original appraisal and require a revised valuation.

For the permanent loan to close (or for a CTP loan to convert), the appraiser must perform a final inspection confirming that the construction substantially conforms to the plans and specifications used for the original appraisal. If market values have declined during the construction period, the appraiser may reduce the value at final inspection, creating a potential loan-to-value issue that the borrower must address with additional equity or a loan restructure.

Rate Lock Strategies for New Construction

Borrowers face three primary rate lock strategies for new construction. First, locking at application with an extended lock period (180-360 days) provides certainty but at a premium cost. Second, floating during construction and locking the permanent rate closer to completion exposes the borrower to rate movement but avoids lock extension costs. Third, using a float-down lock combines an initial rate lock with the option to reduce the rate if market rates decline by a specified amount before conversion.

The optimal strategy depends on the borrower’s risk tolerance, the current rate environment, and the expected construction timeline. In rising rate environments, locking early provides protection even at a premium. In stable or declining rate environments, floating may produce a lower permanent rate. Float-down options offer a middle path but cost more than a simple lock. Borrowers should discuss rate lock strategy with their loan officer before closing, as the decision materially affects the long-term cost of the mortgage.

Related topics include single-family residence mortgage guidelines, multi-unit owner-occupied mortgage guidelines (2-4 units), rural property and acreage mortgage guidelines, fixer-upper and renovation loan options (203k, homestyle), and property type impact on loan eligibility.

Key Factors

Factors relevant to New Construction Mortgage Process
Factor Description Typical Range
Loan Structure (OTC vs. Two-Time-Close) One-time-close eliminates duplicate closing costs and guarantees permanent financing but may carry higher rates. Two-time-close allows independent permanent loan shopping but doubles transaction costs and introduces rate risk. OTC closing cost savings of $2,000-$5,000+. Two-time-close rate risk depends on market conditions during the 6-12 month build .
Extended Rate Lock Premium New construction requires longer rate lock periods than standard purchases, with costs increasing proportionally to lock duration. 180-day locks add approximately 0.25%-0.50% to the rate; 360-day locks may add 0.50%-1.00% compared to 30-day pricing .
Construction Phase Interest Interest accrues only on disbursed funds during construction. Total construction-phase interest depends on build duration, draw pace, and interest rate. For a $400,000 construction loan at 7.0% with a 9-month build, total construction interest may range from $10,000-$16,000 depending on draw timing .
Builder Qualification Requirements Lenders require builders to meet licensing, insurance, experience, and financial stability standards. Using an unapproved builder may delay or prevent loan approval. Minimum 3-5 completed homes in the past 2-3 years, current contractor license, $1M+ general liability insurance are common thresholds .

Examples

One-Time-Close CTP Loan for a Custom Build

Scenario: A borrower purchases a lot for $80,000 and contracts with an approved builder to construct a home for $320,000 (total project cost $400,000). The borrower applies for a one-time-close CTP loan with 20% down ($80,000). The lot is contributed as equity. The lender approves a $320,000 CTP loan with a 270-day extended rate lock at 7.25%.
Outcome: During the 8-month construction period, draws are released at five milestones. The borrower pays interest only on disbursed amounts, totaling approximately $11,500 in construction-phase interest. Upon completion, the CO is issued, the appraiser certifies completion, and the loan converts to a 30-year fixed mortgage at 7.25%. The borrower begins making principal-and-interest payments of approximately $2,183 per month. Total closing costs were incurred once, saving an estimated $3,800 compared to a two-time-close structure.

Two-Time-Close with Rate Improvement at Permanent Closing

Scenario: A borrower uses a two-time-close approach. The construction loan closes at 8.0% interest-only for 10 months. During construction, the Federal Reserve cuts rates. At completion, the borrower shops multiple lenders for the permanent mortgage and secures a 30-year fixed rate of 6.50%.
Outcome: The borrower paid approximately $14,000 in construction-phase interest and incurred $4,200 in additional closing costs for the second transaction. However, the permanent rate of 6.50% (versus the 7.25% that would have been locked under a one-time-close) saves approximately $170 per month on a $320,000 loan. Over 30 years, the lower rate saves approximately $61,000 in total interest, substantially offsetting the duplicate closing costs and higher construction-phase interest. This outcome was not guaranteed and depended on favorable rate movement.

Spec Home Purchase with Standard Financing

Scenario: A borrower contracts to purchase a newly built spec home for $475,000 from a production builder. The home is 90% complete at contract with an estimated 45-day completion timeline. The borrower applies for a standard conventional purchase mortgage with 10% down.
Outcome: Because the home will be finished within the standard rate lock window, no construction loan is needed. The lender orders a standard appraisal (not subject-to-completion because the home is substantially complete). The appraisal confirms the value at $480,000. The loan closes as a standard purchase two weeks after the CO is issued. The borrower avoids construction loan complexity, draw schedules, and extended rate lock costs entirely.

Construction Delay Exhausts Rate Lock and Interest Reserve

Scenario: A borrower closes a one-time-close CTP loan with a 270-day rate lock and an interest reserve sized for 9 months of construction. Unexpected supply chain delays and a failed rough-in inspection extend the build to 13 months.
Outcome: The rate lock expires at 270 days, and the borrower pays a 90-day extension at a cost of 0.375% of the loan amount ($1,200 on a $320,000 loan). The interest reserve is depleted at month 9, requiring the borrower to make interest-only payments out of pocket for the remaining 4 months (approximately $5,800 total). The total additional cost from the delay is approximately $7,000. The borrower's contingency reserves cover the shortfall, but the experience illustrates the financial risk of construction timeline uncertainty.

Common Mistakes to Avoid

  • Not factoring in construction-phase interest when budgeting for a new build

    Borrowers often focus on the permanent mortgage payment without accounting for the interest-only payments owed during construction. On a $400,000 construction loan at 7.0% with a 10-month build, construction-phase interest can total $12,000-$18,000 depending on draw timing. This cost must be budgeted separately from the down payment and closing costs.

  • Assuming the builder's reputation alone is sufficient due diligence

    Even builders with strong local reputations can face financial difficulty, subcontractor disputes, or licensing issues. Borrowers should independently verify licensing, insurance, complaint records, and financial stability. The lender's builder approval process covers minimum standards but does not substitute for the borrower's own research.

  • Choosing a two-time-close structure solely to avoid extended lock premiums without considering rate risk

    Borrowers sometimes select a two-time-close loan to save on extended rate lock costs, but this exposes them to the risk that rates increase during construction. A 1.0% rate increase on a $350,000 loan adds approximately $230 per month to the permanent payment. The rate lock premium savings must be weighed against this potential cost.

  • Failing to understand the builder deposit refund terms in the purchase contract

    Builder deposits of $5,000-$25,000 or more may be partially or fully non-refundable after certain milestones. Borrowers who assume deposits are fully refundable if financing falls through may lose substantial sums. The refund provisions are in the builder's purchase contract, not the lender's loan documents, and must be reviewed carefully before signing.

  • Making unauthorized changes during construction without notifying the lender

    Material changes to the plans, finishes, or scope of construction can invalidate the subject-to-completion appraisal. If the completed home differs significantly from the plans used for the appraisal, the lender may require a new appraisal at additional cost and potential valuation risk. All change orders should be documented and communicated to the lender.

  • Underestimating the construction timeline and not sizing the rate lock and interest reserve accordingly

    Construction delays are common due to weather, material shortages, permitting delays, and subcontractor scheduling. Borrowers who lock for the minimum expected build time and size the interest reserve with no cushion face costly extensions and out-of-pocket interest payments if the project runs long. Adding a 20-30% time buffer to the expected build duration is prudent.

Documents You May Need

  • Complete architectural plans and specifications
  • Fixed-price or cost-plus construction contract signed by borrower and builder
  • Builder licensing documentation (state contractor license, current and active)
  • Builder insurance certificates (general liability, builder's risk, workers' compensation)
  • Builder financial references or financial statements
  • Lot deed or purchase contract (if lot is being acquired as part of the project)
  • Draw schedule and construction timeline provided by builder
  • Itemized construction budget with line-item cost breakdown
  • Well and septic permits (if applicable, for rural construction sites)
  • Building permit issued by local jurisdiction
  • Certificate of occupancy (at completion, required for loan conversion)

Frequently Asked Questions

What is the difference between a one-time-close and a two-time-close construction loan?
A one-time-close loan documents both the construction financing and the permanent mortgage in a single closing, eliminating duplicate closing costs and guaranteeing the permanent loan terms upfront. A two-time-close loan involves separate closings for the construction loan and the permanent mortgage, allowing the borrower to shop for permanent financing independently but requiring two sets of closing costs and exposing the borrower to interest rate risk between closings.
Can I use an FHA, VA, or USDA loan for new construction?
Yes. FHA, VA, and USDA each offer one-time-close construction-to-permanent loan programs, though not all lenders participate in these programs. Borrowers must meet the standard eligibility requirements for each program (FHA mortgage insurance, VA entitlement, USDA income and location eligibility) in addition to construction-specific requirements. Availability varies by lender, so borrowers may need to shop specifically for lenders that offer government-backed construction financing .
How does the appraisal work if the home hasn't been built yet?
The appraiser performs a subject-to-completion appraisal, reviewing the plans, specifications, and construction contract to estimate what the completed home will be worth. Comparable sales of similar finished homes in the area provide the market data. Once construction is complete, the appraiser performs a final inspection to confirm the home was built according to the original plans. If market conditions have changed or the home differs materially from the plans, the final value may differ from the original estimate.
What happens if my builder goes out of business during construction?
Builder default or insolvency during construction is a serious risk. The lender typically stops disbursing draws immediately. The borrower must find a replacement builder to complete the project, which often costs significantly more than the remaining original contract amount due to mobilization costs and the new builder's unfamiliarity with the project. Builder's risk insurance may cover some losses. Some states have contractor recovery funds that provide limited reimbursement. Borrowers should verify builder financial stability and insurance coverage before starting construction.
Do I make mortgage payments during the construction phase?
During construction, borrowers typically make interest-only payments on the amount that has been disbursed to date. Since the full loan is not disbursed at once, early payments are relatively small and grow as more draws are released. Some loans include an interest reserve that covers these payments automatically. Full principal-and-interest payments begin only after the loan converts to permanent financing upon completion and certificate of occupancy issuance.
How long can I lock the interest rate for new construction?
Extended rate locks for new construction are commonly available for 180, 270, or 360 days. Longer lock periods carry higher premiums, typically adding 0.25% to 1.00% to the rate compared to standard 30-day pricing. If construction exceeds the lock period, extensions may be available at additional cost (typically 0.125%-0.375% per extension). Float-down options may be available to allow rate reduction if market rates fall during the lock period .
What is an interest reserve and do I need one?
An interest reserve is a portion of the construction loan set aside to make the interest-only payments during the build phase. Instead of paying interest out of pocket each month, the reserve automatically covers the payments. The reserve amount is included in the total loan balance, so you are borrowing to cover construction-phase interest. Whether you need one depends on your cash flow during construction. If you are also paying rent or a mortgage on your current home, an interest reserve can reduce cash flow pressure during the build.
Can I be my own general contractor (owner-builder) and get a construction loan?
Most construction lenders do not finance owner-builder projects because they lack the licensing, insurance, and construction management experience that lenders require. Some portfolio lenders and credit unions offer owner-builder programs with stricter requirements, including higher down payments (25-30%), construction management experience, and additional inspections. Owner-builder construction loans are significantly harder to obtain and typically more expensive than builder-managed construction loans .
What is a certificate of occupancy and why does it matter for my loan?
A certificate of occupancy (CO) is issued by the local building authority after final inspections confirm the home meets building codes and is safe for habitation. The CO is required for a CTP loan to convert from construction to permanent financing and for the permanent mortgage to close in a two-time-close structure. Without a CO, you cannot legally occupy the home and the lender will not finalize the permanent loan. Delays in obtaining the CO directly delay your ability to move in and complete the financing.
How do change orders during construction affect my loan?
Change orders that increase the construction cost may require additional borrower funds if they exceed the approved loan amount and contingency reserve. Change orders that materially alter the home's design, size, or quality may require the lender to review an updated appraisal. All change orders should be documented in writing, signed by both the borrower and builder, and communicated to the lender. Undocumented changes can create discrepancies between the appraised home and the completed home, potentially delaying loan conversion.
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