Construction Loans: Financing Your Build from Start to Finish

If you’re considering a new build for your primary residence or as part of a real estate investment strategy, conventional home financing simply doesn’t apply. Traditional home loans are designed for existing structures—not for the home you plan to build.

Construction loans offer financing for new builds, allowing borrowers to secure land and fund the construction process itself. These specialized financing options provide flexibility for developers and investors, but they also operate quite differently from traditional mortgages. 

In this article, we explore construction loans, how they work, and what borrowers and real estate investors should consider as they evaluate funding options.

What Is a Construction Loan?

A construction loan is a short-term financing option designed to fund the building of a new home or real estate project. Instead of receiving the full amount of the loan upfront, borrowers access funds in stages as construction progresses.

There are several types of construction loans. Some include both the land purchase and construction costs and convert into a conventional housing loan once the project is complete. Others cover only the building phase and require separate long-term financing (or a cash payoff) once construction is completed.

Because the property does not yet exist, lenders rely heavily on project plans, builder qualifications, and projected property value when evaluating a construction loan application.

Construction Loans vs. Traditional Mortgages

A traditional mortgage loan can only be used for existing homes. If a property has not yet been built, a construction loan or other alternative financing option must be used. 

Construction loans differ from traditional home loans in several important ways:

• Funds are released in stages. Instead of receiving the full loan amount at closing, funds are distributed in periodic “draws” as construction milestones are completed.
• Projects require inspections. Lenders typically require inspections at various stages of construction to confirm progress before releasing additional funds. Most projects see 4-6 inspections on average.
• Payments are structured differently. Repayment of a construction loan also occurs in stages. During construction, borrowers typically make interest-only payments on the funds that have been drawn so far.
• Approval includes project evaluation. Construction lenders not only consider the creditworthiness of the borrower and the current value of the property, but also evaluate its potential value after completion. Borrowers must provide detailed building plans and contractor credentials with their credit application.

Construction Loan Rates & Down Payments

Unlike a conventional mortgage loan, where the home serves as a guaranteed asset, construction loans are built on good intentions and a home that does not yet exist.

Because of this uncertainty, lenders see construction loans as higher risk than traditional mortgages. As a result, construction loans typically charge higher interest rates, may require a higher down payment (up to 20%), and charge additional fees for inspections and administration of the funds.

For real estate investors, these requirements are an important consideration when calculating the total cost of a project.

Types of Construction Loans

There are four primary types of construction loans available to borrowers and investors.

Construction-to-Permanent Loans

Construction-to-permanent loans combine two stages of financing into a single loan.

During the building phase, borrowers make interest-only payments as funds are drawn. Once the house is complete and a certificate of occupancy is issued, the loan converts to a conventional housing loan, with regular principal and interest payments.

This structure simplifies the process by requiring only one closing and one set of closing costs. It also guarantees funding for the completed project. In addition to the funding available from private lenders, some government-backed loan options—including FHA and VA construction-to-permanent loans—offer this structure for qualifying buyers.

Construction-Only Loans

Construction-only loans cover the building phase of a project. When the build is completed, the balance becomes due.

Borrowers typically repay a construction-only loan by:

• Paying the balance in cash
• Refinancing into a traditional mortgage loan
• Selling the completed property

Because they require separate long-term financing, construction-only loans are often called “two-time-close construction loans.” Borrowers also risk changing mortgage terms or, if their financial situation changes, trouble securing a home loan when the project is complete. However, it can offer flexibility, especially for investors who plan to sell or refinance the property once construction is complete.

Renovation Loans

Renovation loans are designed for improving or rebuilding existing properties rather than constructing a new home from the ground up. 

Like a construction loan, these loans typically use draw schedules to disburse funds according to project milestones. They require thoughtful planning prior to approval and regular inspections throughout the building process.

These loans are often used when purchasing a fixer-upper, updating or expanding an existing home, or modernizing an investment property. 

Homeowners may also consider alternatives such as a home equity loan or home equity line of credit (HELOC), which borrow against the property’s existing equity.

Owner-Builder Construction Loans

Owner-builder construction loans are construction-only or construction-to-permanent loans available to borrowers who plan to act as their own contractor during construction. Because of the specialized knowledge required to build a home, many lenders only offer these loans to licensed home builders. 

How Do Construction Loans Work?

To qualify for a construction loan, borrowers must not only meet all financial requirements, but also provide detailed information about the intended project. This makes the application for a construction loan more complex than a conventional mortgage loan, with some borrowers doing a significant amount of legwork before the property is even secured.

During active construction, funds are released through scheduled draws and usually disbursed directly to the builder based on planned milestones and the results of regular inspections. Borrowers will typically make interest-only payments on the funding that has been disbursed to date.

For construction-to-permanent loans, borrowers typically have up to one year to complete their building project. The loan will convert to a traditional mortgage once a final inspection is completed and a certificate of occupancy is issued. Construction-only and renovation loans may have more flexible timelines, depending on the lender.

Expenses Covered by Construction Loans

Depending on the loan structure, construction loans may cover a variety of project-related expenses, including:

• The purchase price of the land
• Contractor labor
• Building materials
• Permits and inspection fees
• Site preparation and utility installation

Lenders may allow certain design costs to be included if they are directly tied to the construction process, though preliminary architectural work is often paid separately. Some upfront costs may also count toward your down payment, if they align with allowable loan expenses.

Risks and Benefits of Construction Loans

Construction loans offer significant advantages for borrowers who want to build a custom home or develop a property investment. However, any building project comes with inherent risks that can affect both project completion and loan repayment. 

Benefits

• Flexibility to design and build a custom property
• Financing for homes that don’t yet exist
• Ability to increase property value through development

Risks

• Higher interest rates and larger down payments
• Construction delays due to weather, labor shortages, or material costs
• Project overruns that require additional financing

For borrowers using construction-only loans, there is also a risk of secondary loan qualification. If a borrower’s financial situation changes during the building process, securing long-term funding may become more difficult.

How to Apply for a Construction Loan

As with any mortgage loan, a construction loan requires preparation and detailed documentation to demonstrate your financial suitability, the plans for the property, and the expected value of the building project.

Borrowers typically need the following to qualify for a construction loan:

1. Good credit and financial standing: Many lenders require a minimum credit score of 680, though some may allow as low as 620. You will also need to prove your income and ability to pay the loan.
2. Down payment: Construction loans often require 15-20% down, though requirements vary by lender and project type.
3. Detailed construction plan: Borrowers must provide detailed building plans, cost estimates, and a timeline from a licensed builder or contractor. 
4. Property appraisal: An appraiser will assess the building plans, the value of the lot, and other factors to determine the expected future value of the home.

Because this process can take time, many borrowers begin preparing their documentation before securing the property.

Construction Loans FAQs

Do real estate investors qualify for construction loans?

Yes. Real estate investors regularly use construction loans to finance new builds, spec homes, and development projects. Investors may also use specialized financing such as DSCR loans, bridge loans, or fix-and-flip loans, depending on their overall investment strategy.

How long do construction loans last?

Most construction loans are short-term loans lasting 6-18 months, depending on the scope of the project. Construction-to-permanent loans convert into long-term home loans once the home is completed.

Can you use a construction loan to buy land?

Yes. Many construction-only and construction-to-permanent loans include the purchase of land as part of the total financing package.

Are the requirements of a construction loan the same as a traditional mortgage loan?

Because of the risks associated with a construction loan, many lenders require a higher credit score and larger down payment. Detailed construction plans must be included with the application, and borrowers can expect to pay higher interest rates than with a conventional housing loan.

What happens if construction takes longer than expected?

If delays occur, borrowers may need to request a loan extension from the lender. Extensions may involve additional fees and charges, so planning for potential delays is an important part of budgeting for a construction project.

Get Started With Ternus Today

If a new build is part of your real estate investment strategy, a construction loan may be the right financing solution. At Ternus, we provide straightforward lending options to help investors move quickly on opportunities to build new homes and improve existing properties. 

Our loan programs include:

• Fix-and-flip loans
• Bridge loans
• Wholetail loans
• DSCR loans
• Transactional funding

Connect with our team today to learn more about how Ternus can help you build your next project.