Construction Loan
A construction loan is a short-term financing instrument used to fund the building of a new residential property. The lender disburses funds in stages (draws) as construction milestones are completed, and the borrower typically pays interest only during the build period before converting to permanent financing.
What This Means
How Construction Loans Work
Unlike standard mortgages that provide a lump sum at closing, construction loans release funds incrementally through a draw schedule tied to verified construction milestones. A lender-approved inspector confirms completion of each phase (foundation, framing, mechanical, finish) before the next disbursement. During the construction period, which typically lasts , the borrower makes interest-only payments on the amount drawn.
Construction-to-Permanent vs. Stand-Alone
Two primary structures exist:
- Construction-to-permanent (CTP) loans convert automatically into a standard mortgage once the certificate of occupancy is issued. This involves a single closing and one set of closing costs.
- Stand-alone construction loans require a separate permanent mortgage after construction is complete, meaning two closings and two sets of fees.
CTP loans are more common for owner-occupied builds because they reduce cost and complexity. Stand-alone loans may be used when the borrower wants flexibility to shop for permanent financing after the build.
Qualification Considerations
Construction loans carry higher risk for lenders, which translates to stricter requirements. Expect minimum credit scores of , down payments of , and detailed documentation including builder contracts, architectural plans, and a construction timeline. The lender underwrites both the borrower and the builder, often requiring the builder to be licensed and insured with a track record of completed projects.