What Is Construction Loan?

A construction loan is a short-term loan used to finance the building of a new home, with funds released in stages (called draws) as construction progresses. The loan term typically lasts 12 to 18 months, and you pay interest only on the amount disbursed. Once construction is complete, the loan either converts to a permanent mortgage or is paid off with a separate mortgage.

On a $500,000 construction project, you might put 20%–25% down ($100,000–$125,000). During the build, if $200,000 has been drawn, you pay interest only on that $200,000—about $1,167 per month at 7%. Construction loan rates are generally 1%–2% higher than standard mortgage rates, and closing costs apply both for the construction loan and the permanent loan unless you use a one-time-close product.

Key Facts

• Typical loan term: 12–18 months during construction
• Down payment: 20%–25% of total project cost
• Interest during construction: Charged only on funds disbursed, not the full loan amount
• One-time-close option: Combines construction and permanent financing into a single closing, saving on fees

Frequently Asked Questions

What is the difference between a construction-to-permanent loan and a standalone construction loan?

A construction-to-permanent (one-time-close) loan automatically converts to a standard mortgage when the home is finished, with one set of closing costs. A standalone construction loan requires you to apply and close on a separate mortgage after construction, meaning two sets of closing costs.

Do you need to already own the land to get a construction loan?

Not necessarily. Many construction loans can include the cost of purchasing the lot. If you already own the land, its value may count toward your down payment equity, reducing the cash you need to bring to closing.