Construction Loan
A construction loan is a short-term mortgage used to finance the building of a new home or major renovation. Funds are disbursed in draws as construction milestones are reached, rather than in a lump sum at closing. Construction loans are frequently provided by direct lenders — including community banks, regional mortgage companies, and specialty lenders — because the draw management and inspection process requires hands-on involvement that wholesale channels struggle to accommodate.
Construction loans come in two primary structures. A construction-to-permanent loan (also called a one-time-close or OTC loan) converts to a permanent mortgage when construction is complete, with a single closing, a single set of closing costs, and a rate locked at the start. A two-time-close construction loan requires a separate closing for the construction phase and another at conversion — more flexibility, but double the closing costs. Most direct lenders who specialize in construction lending offer both.
During the construction phase, the borrower typically pays interest only on the funds drawn down. On a $500,000 construction loan with 50% drawn, the monthly interest payment at 8% would be approximately $1,667 — far less than a full principal-and-interest payment on the same balance. Draw schedules vary by direct lender but commonly follow four to six milestones: foundation, framing, rough-in (plumbing/electrical), drywall, and completion. An inspector from the direct lender verifies each milestone before releasing funds.
Construction loan rates are generally 0.5%–1.5% above conventional mortgage rates, reflecting the additional risk (no existing collateral) and administrative burden. Typical down payment requirements range from 10%–20% of the total project cost (land plus construction). Direct lenders who specialize in construction lending include community banks, regional portfolio lenders, and specialty non-bank lenders. Large national mortgage companies rarely offer construction products due to the complexity involved.
Key Takeaway
A construction loan is a short-term mortgage used to finance the building of a new home or major renovation. Funds are disbursed in draws as construction milestones are reached, rather than in a lump sum at closing. Construction loans are frequently provided by direct lenders — including community banks, regional mortgage companies, and specialty lenders — because the draw management and inspection process requires hands-on involvement that wholesale channels struggle to accommodate.
Related Terms
Frequently Asked Questions
Yes. Many direct lenders — especially community banks, regional mortgage companies, and specialty non-bank lenders — offer construction loans. Large wholesale-focused lenders and brokers typically cannot manage the draw disbursement process that construction lending requires.
Most direct lenders require 10%–20% of the total project cost (land plus construction budget) as a down payment. Some programs allow as little as 5% down for owner-occupied primary residences.
Construction loans typically have 6–18 month terms. If construction isn't complete by the maturity date, the borrower may request an extension from the direct lender, usually for an extension fee of 0.25%–0.5% of the loan balance.
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