This episode is for you if you’re confused about how construction loans work.
And listen… don’t feel bad about this! I’ve been through the home build process myself, and I STILL find construction loans a little confusing.
So honestly, this is as much a refresher for me as it might be new information for you.
I wanted to record this episode after I got off a recent call with my BEFORE YOU BUILD℠ clients a couple of weeks ago. One of the women was talking about the builder she’s hiring and how he’s very meticulous (which is amazing!), but also pretty slow when it comes to building homes.
Now, the meticulous part? That’s awesome. However, here’s the problem: you only have a limited time frame with a construction loan. And when you start creeping over that construction loan term, things get really, REALLY expensive.
Nervous about blowing your budget while building? Grab a seat in my FREE on-demand class, ‘The 3 Most Expensive Home Building Mistakes (And How to Avoid Them!)’.
How Construction Loans Work
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Below is the full transcript for this podcast episode.
Welcome back to the Before You Build podcast. I’m your host Carrie Barker (aka Caroline On Design), and today in episode 87, we’re talking all about how construction loans work. I’m answering the most asked questions so that you know exactly what to expect!
A Beginner’s Guide to Construction Loans
Building a custom home is super exciting … but figuring out how to finance it is another story.
This is where many first-time home builders get super confused.
If you’ve started researching how to fund your build, you’ve probably read a little bit about construction loans.
But honestly? How construction loans work isn’t always crystal clear. And when you’re already trying to figure out floor plans, budgets, and whether you REALLY need that fancy kitchen island … the last thing you need is more confusion.
Most people building for the first time feel completely overwhelmed by the financing piece.
Believe me … you are NOT alone if you’ve been up late at night (unable to sleep) and googling “construction loans explained”!
I’m going to walk you through the most common questions about how construction loans work so you can approach this part of your build with clarity, confidence, and way less stress.
Because remember … when it comes to building a home, the more you understand upfront, the fewer surprises you’ll run into later.
(And trust me, surprises during a home build usually cost a lot of money.)
Disclaimer: I’m not a loan officer, and this isn’t meant to replace professional lending advice. My goal is to give you a simple overview so you can feel more confident heading into conversations with your builder or lender. Please consult with a local loan officer for the most accurate and up-to-date information.
What Is a Construction Loan?
Think of a construction loan as a “pay-as-you-go” version of home financing.
Unlike a traditional mortgage (where you get one big chunk of money to buy your house that’s already built), a construction loan gives you money in phases as your house actually gets built.
This setup protects both you AND your lender.
Your bank is protected because they aren’t handing over hundreds of thousands of dollars for a house that doesn’t exist yet, and you’re protected because you aren’t paying interest on money that hasn’t been used yet.
So it’s a win-win for both of you.
How Construction Loans Work
Once you’re approved for a construction loan, your lender sets up what’s called a “draw schedule.”
This is tied to specific milestones in your build process, like laying the foundation, framing, roofing, electrical rough-in, etc.
As each phase gets completed and verified by an inspector, the bank releases a portion of the funds to your builder.
Here’s what that means for YOU:
✅ You’ll typically make interest-only payments during construction on just the amount that’s been released so far (not the full loan amount!)
✅ Once construction wraps up, your loan will either convert into a regular mortgage, OR you’ll need to get a separate mortgage to pay off the construction loan
📌 Want a deeper dive into the two types of construction loans? I’ve got you covered in my blog post: How to Finance Your Home Build: Two Loan Types Explained.
How Long Are Construction Loan Terms?
Most construction loans last around 6 to 18 months, depending on your type of build. A custom home will be on the higher end of the timing.
18 months seems like plenty of time until you factor in weather delays, permit hiccups, subcontractor issues, and other unexpected delays.
This timeline is meant to give you enough time to build your home without the bank getting antsy about its money.
BUT (and this is super important!) … it means you need to stay reasonably on schedule.
If delays push your build past the loan term, you might need to apply for an extension, which can come with extra fees, higher interest rates, or both.
And I know you don’t want surprise fees when you’re already spending so much money on your house!
This is exactly why having a solid plan BEFORE construction begins is so crucial.
When you know what you want, have made all your major decisions upfront, and have everything mapped out ahead of time, you’re significantly less likely to encounter delays that could disrupt your loan timeline.
(That’s one of the key things we focus on inside BEFORE YOU BUILD℠ … making sure you’re prepared before you break ground so your build stays on track and you avoid costly delays that slow down construction.)
Do You Pay Closing Costs on a Construction Loan?
Yes! Just like with a regular mortgage, there are closing costs associated with a construction loan.
These typically include:
- Loan origination fees
- Title searches
- Appraisal fees (and sometimes multiple appraisals)
- Permits and inspections
- Attorney fees (in some states)
You should expect to pay around 2–5% of the total loan amount in closing costs.
So if you’re borrowing $400,000, you might be looking at $8,000 to $20,000 in closing costs.
Again, please get the most accurate information from your local lender, who can give you a detailed breakdown of these fees during the approval process.
Do You Need 20% Down for a Construction Loan?
Not necessarily. But here’s the deal: a bigger down payment can definitely help you get approved and get better loan terms.
I’m not an expert in loans, but here’s a general breakdown:
FHA Loans: Typically, you’ll need to put down about 3.5% down
Conventional Loans: Usually require 10–20% down
VA or USDA Loans: You may be able to get a loan for 0% down if you qualify
Your down payment (plus your credit score and income) will help determine how much you can borrow and what interest rate you’ll get.
The stronger your financial profile, the better terms you’ll typically get.
Important note: These are general guidelines, and loan requirements can vary significantly based on your specific situation and location. Always connect with a qualified loan officer to obtain accurate information about down payment requirements for your specific build and financial situation.
Is It Harder to Get a Construction Loan Than a Mortgage?
Yes, it’s typically harder.
Construction loans are considered riskier for lenders because there’s no actual house as collateral yet. So that makes perfect sense.
You’re essentially asking the lender to fund your house that only exists in your imagination and on some blueprints.
To get a construction loan, you’ll likely need: (and this is all in the show notes)
- A detailed construction budget and timeline
- Complete floor plans and blueprints
- A signed agreement with a licensed, insured builder
- A higher credit score (usually 680+ minimum)
- Proof of stable income and a low debt-to-income ratio
- Sometimes, even construction experience or a co-signer
It might feel like a lot of hoops to jump through, but here’s the good news … when you go into the process well-prepared with all your documents organized and a clear plan, you’ll be so far ahead of most first-time builders.
And that preparation? That’s exactly what makes the difference between a smooth loan process and a stressful one.
Now, even if you’re in the very beginning stages and don’t have blueprints or timelines yet, that’s okay. You can still talk to a lender and gather information, as well as get a good idea of how much you’ll be qualified to borrow for your house.
Do You Make Monthly Payments on a Construction Loan?
Yes, but it’s different from your monthly payments on a mortgage.
With a construction loan, you’ll typically make interest-only payments based on how much of the loan you’ve used.
So if your total loan is $400k, but only $100k has been released for the foundation and framing, you’re only paying interest on that $100k. And you’re not paying principal.
This is a really good thing because your payments start small and gradually increase as more of your house is built, and consequently, more money is released.
The nice thing is that you’re only paying interest on what you’ve spent … not on the full amount of your loan.
Once your house is complete, your loan converts to a permanent mortgage, and that is when you start making regular monthly payments that include both principal and interest … just like a normal mortgage.
How Much Can You Borrow with a Construction Loan?
This depends on several factors:
- Your credit score and income
- The appraised value of your future home
- Your down payment amount
- Your debt-to-income ratio
- The loan-to-value ratio that the lender allows
Generally, lenders will let you borrow up to 80%–90% of the appraised value of the completed home. This can include the cost of your land if it’s part of the loan.
Here’s an important note: The appraised value is based on what your home will be worth when it’s FINISHED, not what it costs to build. Sometimes these numbers are different, so don’t be surprised if you can’t borrow the full construction cost.
What Happens If You Don’t Use the Full Construction Loan Amount?
Again, you only pay interest on the funds you actually use.
If you finish your build under budget (which can happen with smart planning!), the remaining funds are not released.
Your final mortgage will reflect the actual amount you borrowed, not the full approved amount.
Pro tip: Building your home under budget is WAY more likely when you plan ahead and know your priorities from the start, so that you avoid last-minute expensive changes.
(This is exactly what my BEFORE YOU BUILD℠ program helps you do … create a clear plan and a realistic budget so you can avoid those costly surprises and come in on budget like I did or even under budget like several of my clients have!)
The Bottom Line on Construction Loans
Construction loans seem a little complicated at first glance, but they’re really just one more piece of the home-building puzzle. And honestly? You can totally master this process with the right preparation and guidance.
The key is understanding how construction loans work BEFORE you need one, so you can:
✅ Budget accurately for your closing costs and down payment
✅ Choose the right loan type for your situation
✅ Plan your building timeline to avoid expensive loan extensions
✅ Prepare all required documents ahead of time
✅ Work with your builder to stay on schedule and on time
When you understand how construction loans work and make intentional choices based on your priorities, you’ll set yourself up for a smoother, less stressful build.
Plus, you’ll end up with a home you absolutely love instead of one full of “I wish we had done this differently …” moments, or, even worse, you completely blow your construction loan budget and you can’t even complete building your house.
Next Steps
If you’re feeling a little overwhelmed by all the moving pieces (construction loans, budgets, floor plans, choosing a builder), you’re definitely not alone.
Most people building their first custom home feel exactly the same way.
The good news is that you don’t have to figure this out on your own.
I’ve just released a free on-demand class that breaks down the three most expensive mistakes I see people make when building a custom home. More importantly, I teach you how to avoid these mistakes, so you can build with confidence, clarity, and a strategic plan to stick to your budget.
Trust me, spending 45 minutes watching this class now could save you months of overwhelm and thousands of dollars in the future.
Plus, you’ll walk away feeling SO much more confident about your entire home build … not just the financing piece!
Grab your seat at carolineondesign.com/free-training … I’ll see you there!
