One-Time-Close Construction Loans
Two-Time-Close Construction Loans
Construction Loan Details
Finding the Right Lender
Getting Pre-Approved
Applying for a Construction Loan
Financing for Owner-Builders        View all FINANCE articles

Unless you are paying cash for your project, you will need a construction loan to pay for the materials and labor, and you can use it to buy the land as well. Construction loans are a little more complicated than conventional mortgage loans because you are borrowing money for a short term on something that doesn’t yet exist. The bank wants assurances that you (and your contractor if you are hiring one) can get the house built on time and on budget.

If you are converting the construction loan to a mortgage when the building is completed, the bank also wants to know that the finished building plus land will have a high enough appraised value to support the mortgage. Because the lender needs to know the story behind the project, and believe that you can make it happen, construction loans are sometimes referred to as “story loans.” There are many variations on these types of loans from lender to lender, and they change frequently, so you should talk to a few different lenders to see what plan is best for you.

Two types of construction loans. The two basic types of construction loans used by homeowners are one-time-close loans, and two-time-close loans. In all construction loans, money is disbursed by the lender based on a pre-established draw schedule, so much money upon completion of the foundation, so much upon completion of the rough frame, and so on. The goal is to only pay for what has been completed, minus retainage, typically 10% of the cost of the project, which is held back until everything is completed properly and the owner is issued a certificate of occupancy (CO).

These are the most popular type of construction loan for consumers, but are now difficult to find in some areas. Also called “all-in-one loans” or “construction-to-permanent loans”, these wrap the construction loan and the mortgage on the completed project into a single loan. These loans are best when you have a clear handle on the design, costs, and schedule as the terms are not easy to modify.

The loan has one approval process, and one closing, simplifying the process and reducing the closing costs. Within this basic structure, there are several variations. Many charge a higher rate for the construction loan than the permanent financing. Typically, the borrower can choose from the portfolio of mortgages offered by the lender such as 30-year-fixed, or various ARM’s (adjustable rate mortgages). Some banks will let you lock in a fixed rate with a “float-down” option allowing you to get a lower rate if rates have fallen, for a fee of course. There may be penalties if the construction phase of the loan exceeds 12 months.

Paying a slightly higher rate on the construction phase of the loan is usually not significant, since the loan is short-term. For example, paying a extra 0.5 percent on a $200,000 construction loan over six months, would only add no more than $250 to your borrowing costs.

Construction loans are typically interest-only and you will pay only on the money that has been disbursed. So your loan payments grow as progress is made and more money is released. When the home is completed, the total amount borrowed during the construction loan automatically converts to a permanent mortgage. If you locked in a fixed mortgage rate at closing, but rates have since fallen, you can lower your mortgage rate by paying a fee – if your loan has a float-down option, a feature you will probably want on a fixed rate loan. If you had chosen a variable rate, pegged to the prime or another benchmark, then you will have to pay the current rate at the time the mortgage converts.

If interest rates are stable or rising, locking in the rate at closing makes sense. If rates are falling, a floating rate would be better – at least in the short run. If you have no idea which way rates are headed, a locked rate with a float-down provision may be your best bet.

Pros of one-time-close construction loans:

  • You pay just one set of closing costs.
  • You are approved at the same time for both construction and permanent financing.
  • Multiple options for permanent financing give you flexibility.

Cons of one-time-close construction loans:

  • If you spend more than the construction mortgage, you may need to take out a second loan, and pay additional closing costs.
  • Permanent rates may be a little higher than with a two-time-close loan.

A two-time-close loan is actually two separate loans – a short-term loan for the construction phase, and then a separate permanent mortgage loan on the completed project. Essentially, you are refinancing when the building is complete and need to get approved and pay closing costs all over again. During the construction phase, you will pay only interest on the money that has been paid out, so your payments will be small, but increase as more money is disbursed. There may be a maximum duration for the loan, such as  12-month, after which penalties kick in.

Because of two loan settlements, closing costs will be greater for this type of loan. However, you may get a better rate on the permanent mortgage as you will be working with mortgage refinance rates, which are typically more competitive than the rates offered in one-time-close loans. While it is easiest to stick with the same lender for the permanent financing, in most cases you will be free to shop around to make sure you are getting the best rate and terms. Also, you will not be locked into a fixed loan amount, and will be able to borrow more if you have added upgrades to the project and increased its value (assuming you qualify for the larger loan).

Pros of a two-time-close loan

  • Greater flexibility to modify the plans and increase loan amount during project.
  • Mortgage rates are often lower than in one-time-close loans.
  • You are usually free to shop around for permanent financing.

Cons of a two-time-close loan

  • Need to be approved twice and pay closing costs twice.
  • If you don’t get approved for permanent financing, you could face foreclosure.

Construction loans are essentially a short-term line of credit extended to you to get your house built. If you don’t use all the money, you only pay interest for the money borrowed.  If you’ll be taking out a construction loan, your total loan expense needs to cover both hard and soft costs. A typical breakdown is shown below:

Typical Construction Loan Breakdown
Land cost $100,000
Hard Construction Costs $250,000
Soft Costs: Plans, permits, fees $20,000
Closing Costs: Loan fees, title, escrow, inspections, appraisal, etc. $4,500
Contingency Reserve(5% of hard costs) $12,500
Interest Reserve $8,000
Total Project Cost $395,000
Appraised Value(completed project) $475,000
Downpayment $55,000
Loan Amount $340,000


Owner’s equity. With construction loans, banks want the borrower to have some “skin in the game” in the form of owner’s equity. If you are borrowing on the land as well as the construction, you will need to make a substantial down payment of 20% to 25% on the land purchased, and then the bank will typically loan 80% or more of the construction costs, as long as the total loan does not exceed 75% or 80% of the value of the completed project. The land is assumed to account for 25% to 33% of the value of the completed project.  If you already own the land, then the land will count as equity in the project, and you may be able to borrow 100% of the construction cost.

Contingency provision. Since many projects exceed the loan amount, loans often have a built-in contingency of 5% to 10% over the estimated cost. To access this money, you may need documentation in the form of a change order, describing the additional work or more expensive materials chosen and the resulting upcharge. Some banks, however, will not pay for changes with or without a change order.

Interest reserve. Another peculiarity of construction loans is that most people make no payments at all during the construction phase. Assuming that you don’t have extra cash in your pocket during construction, most loans include an “interest reserve,” which is money lent to you to make the interest payments. The money is stored in an escrow account and paid back to the bank as interest. The interest is considered part of the cost of construction by your contractor, or by you as an owner-builder.

Draw schedule. In general, the lender does not want to disburse more money than the value of the completed work. Nor do you if you are hiring a general contractor. If the contractor has completed $50,000 worth of work and has been paid $75,000, neither you or the bank are likely to recoup the difference if the builder leaves town, goes bankrupt, or for whatever reason does not complete the job. For that reason, you and the bank will need to establish a draw schedule based on the value of each phase of the work, called a schedule of values.

If you are not borrowing money, you will still need to establish a draw schedule with your contractor so that you don’t get ahead of the work completed. It’s not your job to play banker and provide your contractor with working capital or extra spending money. However, it’s reasonable for the contractor to ask for money to cover the deposit on special-order items. If you are putting up a lot of money, it’s best to put the orders in your name. If anything goes wrong along the way, at least you’ll own the 20 high-end windows you’ve paid for.

Insurance. You construction loan will also require that you or your contractor carry General Liability Insurance, covering any harm to people (non-workers) or property caused during the construction process, and  Builders Risk insurance, which covers damage to the unfinished building. The loan — and the law – will also require that your contractor carry Worker’s Comp Insurance if he has any employees. If the contractor does not carry the proper insurance, then you, the owner, can be sued by an injured employee or neighbor whose child is hurt while playing in the unfinished home. You should also ask the contractor list you and your family as “additional insured” on his liability policy.

Typically, the homeowner buys the Builder’s Risk policy, which may convert to homeowner’s insurance when the building is complete. In a renovation, your homeowner’s policy may already include this coverage, or it can be added as a rider.  If your builder does not carry liability insurance, you will need to purchase this on your own before closing on a loan.  Don’t hesitate to ask the contractor why he does not carry full insurance, and reconsider whether this is the person you want to build or remodel your home. You may find it easier to get a loan (and sleep at night) with a fully insured contractor. Talk to your insurance agent about your potential liability and how to protect yourself before getting too far along.

Most construction loans are issue by banks, not mortgage companies, as the loans are typically held by the bank until the building is complete. Since construction loans are more complicated and variable than mortgages, you will want to work with a lender experienced in these loans. And given that not all banks offer all types of construction loans, you should talk to at least a few different banks to see what is available in your community.

You can learn a lot by listening to the lenders’ policies on draw schedules, inspection and payment procedures, and qualification rules, which will vary from bank to bank. Also banks can be a big help in creating a realistic budget for your project – the biggest challenge for most homeowners (as well as many contractors).  Following the bank’s budgeting format can help you with cost control and can also help you obtain a loan from that bank.

Some banks use loan officers employed by the bank, while others work primarily with independent loan officers. In either case, you want a loan officer experienced in construction loans and one who will walk you through the process and protect your best interests.

In most case the loan officers get paid on commission when they release funds. So there is a potential conflict of interest if the loan officer wants to release funds at the end of project and you want the funds withheld until problems are corrected. Even though payments are generally based on physical inspections of the work done, the inspectors are simply looking to see if the work has been completed, not at its quality.

Also different lenders have different policies around construction loans. For example, if you have a mortgage on your current home that you are selling, some lenders will not count that against your borrowing limits. Otherwise you may need to sell your first house before you can obtain a construction mortgage to build your new home.

Different lenders will also offer different rates. Naturally you will also want the best rates and terms available. If the bank you have dealt with for many years is a little higher than a bank you have less confidence in, tell your local bank you’d like to work with them – but can they do a little better on the rate to match their competitor. Since all banks borrow their money at the same rate, they can all lend at the same rate.

Before getting too far ahead with your plans to buy land and build, or to undertake a major remodeling project, it makes sense to find out how much you can borrow. Conversely, once you know you’re borrowing limits, you can tailor your design to your budget realities. You can meet with a loan officer to just gather information, or to get pre-approved if you plan to start the project soon. Pre-approvals typically last for 30 to 90 days, depending on the lender.

Otherwise, you can waste a lot of time and money designing your dream project, only to find that it is not even in the ball park of what you can afford. And once you are in the ballpark, you will still need to make a number of trade-offs during the design process to keep within the budget (9-ft. ceilings vs. better windows, jetted tub vs. tile floor; etc.). Knowing what you can afford will help you make better decisions. You may decide that you want to add inexpensive unfinished space now, such as attic or basement, that you can finish later when you’re a little more flush.

The specific requirements to obtain a loan change from time to time and vary among lenders. but all lenders look at the same three factors: your credit score (FICO), your income-to-debt ratio, and how much equity you will be putting into the project. The higher your credit score and down payment the better your chances are for approval. If you already own the land, you’re in pretty good shape given the high cost of land these days relative to construction costs.

Income-to-debt ratio. The income-to-debt ratio limits how much of your monthly income you can use to pay off debts. Banks look at two numbers: the “front ratio” is the percentage of your monthly gross income (pre-tax) used to pay your monthly debts. The “back ratio” is the same thing but includes your consumer debt. This is expressed as 33/38, typical bank requirements for the front and back ratios.  FHA accepts up to 29/41 for front and back ratios, while the VA accepts a 41 back ratio, but has no guideline for the front ratio.

Equity. Except in the bad old days of the nothing-down, “no-doc” mortgages that helped spawn the financial collapse of 2008, lenders want the borrower to have some “skin in the game.” The more money you have in a project, the less likely you are to default or not complete the project. On construction loans, most lenders today will only loan you 75% of the appraised value of the home, based on the plans and specs. This is called the “Subject to Completion Appraisal,” done by the bank. If you already own the land, you will probably have no problem with this equity contribution, since land costs have risen much faster than construction costs in most areas and usually account for a large share of the total project cost.

If you’ve been pre-approved, the building appraises within the lending limits, and you show up with full documentation and a reputable contractor, you should no problem obtaining the loan. If you are an owner-builder, you will have the additional task of convincing the lender that you can get the project completed on time and on budget. The more cost documentation you bring the better since cost overruns (or underestimates) are the number-one problem with inexperienced builders. Hiring a construction manager  may help you put together a credible package and secure the loan.

To apply for a loan, you’ll need the following, in addition to the standard financial information required for any bank loan:

  • Building lot details: a deed or offer to purchase,  documentation of protective covenants and other deed restrictions
  • A clear description of responsibilities of the architect (if any), and the general contractor, construction manager, or yourself if you are an owner-builder.
  • The builder’s resume, insurance certificates, and credit and banking references
  • Complete set of blueprints and specifications
  • Material’s list in the bank’s format
  • Line-item budget (schedule of values)  in the bank’s format
  • A draw schedule (payment schedule) consistent with the lender’s disbursement procedures.
  • A signed construction contract, including start and completion dates, and provisions for change orders

It is often difficult for owner builders to get construction loans. Since you are being loaned money for something that does not yet exist, you need to convince the bank that can get the job done on time and on budget. They key to this is approaching the bank the same way a contractor would – with professional plans and specs, a detailed estimate, and a proposed construction schedule. You may consider hiring a construction manager, estimator, or other building consultant to help put your package together.

An accurate estimate is essential, since the bank will assign an appraiser to determine the value of your project. If it looks like your estimate is overly optimistic and the bank does not think you can really get the project built for the loan amount, you will either need to borrow more (if you qualify), add more cash to the deal, or scale back elements of the design.

Many building projects come in over budget, and it’s the rare job that comes in under.  An owner-builder’s (or inexperienced contractor’s)  lack of experience can often lead to important items being overlooked in the estimate. Or the project may incur extra costs through design or construction errors, inefficiency, hidden problems, or changes to the plans or specs during the project. A bank wants protection against these uncertainties, so they may want more of your cash in the project as well as evidence that you are well-organized and have done thorough planning in the plans, specs, and budgets. Of course, you don’t want to be surprised any more than the bank does, so make sure you do your homework. Have the house completely designed, built, and paid for on paper before you start borrowing and digging.

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  1. We have applied for a construction loan on land that we own. We are being told by the bank that it’s not our debt ratio that’s a problem but the high balance on one of our credit cards. How can that be a reason to turn us down?

    • buildingadvisor says:

      In general banks are skittish about construction loans, which are more risky than traditional mortgages. In addition to the usual risks, there are risks that the house will not be completed on time and on budget, as well as risks that it will be worth less than the cost of construction when it finished. Also, if the homeowner defaults for any reason, the bank is left with a partially built house

      For these reasons, banks have more stringent lending guidelines on construction loans and typically require higher credit scores, lower debt-to-income ratio, and higher down payments. In addition they must approve the builder, the building plans, and appraised value of house when completed.

      If you are a borderline borrower under their guidelines, they might still approve if you have strong “compensating factors” such as a larger down payment (over 20%), very high credit score (over 740), or extra cash in the bank.

      Carrying a high unpaid balance on a credit card does two things: raises you debt-to-income ratio and lowers your credit score. Since the bank told you that the ratio is OK, maybe it is the credit score that is hurting you.

      I would first ask for clarification on why your loan was rejected, which the bank is required to provide if requested within 60 days under the Equal Credit Opportunity Act (ECOA). Also ask what steps you might take to improve your chances of getting a loan — such a lowering the credit card balance to an acceptable level. If you were denied the loan due to your credit score, the bank is required to tell you your numerical score and the name and contact information for the credit agency they used. Ask how to get a free copy of the credit report, which you are legally entitled to.

      If you feel that the credit report has inaccurate information, not an uncommon occurrence, than you should contact the credit agency to dispute the misinformation. If you have trouble getting your credit score or the credit agency will not fix the inaccurate information, contact the Consumer Finance Protection Bureau (CFPB), a federal agency that supports borrowers.

      Also contact the CFPB if you feel you have been discriminated against due to race, gender, marital status, or age. Lending discrimination is illegal under the Equal Credit Opportunity Act (ECOA), which is enforced by the FTC.

      One option might be a secured construction loan. If you own other property, you may be able to use it as collateral for your construction loan. Collateralized loans reduce the bank’s risk a great deal, making them more likely to open their purse to you. Also, if you already own the property, that can be used to lower your loan-to-value ratio, which is the same as raising your down payment.

      Finally, shop around. Different banks have different policies and practices around construction loans. If you already have a long-standing relationship with a bank, it’s always best to start there. Best of luck in securing a loan and getting your project underway!

  2. I am a disabled Veteran, would I be able to use my VA loan as a construction loan?

    • buildingadvisor says:

      It is possible to obtain a VA construction loan, but not easy. You have to find a bank willing to go along with your plan and most do not like to provide no-downpayment construction loans, even if they are guaranteed by the VA.

      Banks consider construction loans more risky than mortgages, as they are loaning money on the promise that you and your contractor are going to follow through and get the home built on time and on budget – not always the case.

      You can use your VA loan for permanent mortgage financing, which pays off the bank that issued the construction loan. The tricky part is finding a bank (or builder) to finance the construction phase. If you have a bank where you or your family regularly does business, I would start there.

      You might also consider buying a new home from a developer using the VA loan. Larger developers have the financial strength to build homes “on spec” where they finance the construction rather than the buyer.

      Best of luck in getting the financing you need. You can read more at these links:

  3. I am looking for a new construction loan to buy land and build a small home and business. I live in West Virginia and am not sure where to seek for this loan: local bank or out-of-state, or whether to use an internet search to get the best offers and/or intrest rates. Any thoughts or ideas?

  4. Diane Nolte says:

    Is there any way we can borrow down-payment money and roll it into the mortgage after the project is done. We have put a small down payment on a house to be moved (not a mobile home) and need a construction loan. We do not have near enough to put 25% down and want to roll the construction loan over to a USDA guaranteed loan. At that time, we would pay off the friend who loaned us the money for the down payment.

    • buildingadvisor says:

      In general, banks will not allow you to borrow down-payment money. One exception is FHA loans, which may allow you to borrow down-payment funds from specific approved lenders, but these do not include family, friends, or other interested parties.

      All banks, however, will allow friends or relatives to gift you money to use as a down payment. In general, they will want signed documentation by the gift giver certifying that the money is a gift, not a loan.

      While USDA-guaranteed loans are not available for construction loans, FHA does provide 0-downpayment mortgages to qualified borrowers, which could help you out. Another option to consider is an FHA loan. FHA does provide construction-to-permanent loans with lower down payments than required by traditional lenders, so this might work for you if you qualify. Read more on FHA loans.

  5. We took a construction to perm loan and started building .. but unfortunately we did not get the schools we hoped for our special needs kids. Can we walk away now without incurring any loss ?

    • buildingadvisor says:

      Assuming that you have taken out the loan from a bank or mortgage company, you are responsible for the loan. If you default on the loan, you will lose your earnest money and any payments you have made, and your credit rating will take a big hit.

      You can try to sell the house to a third party who is willing to purchase a partially built home. In some cases, you can negotiate with the bank to accept the deed to the house without going through foreclosure. That would spare you future credit problems.

      At this point, you should meet with your loan officer, explain your situation, and see if they are willing to work with you on a solution other than foreclosure.

      You can find a good discussion of these issues at this link.

  6. Miriam Sawtschenko says:

    My in-laws are going to build a home on land that my husband and I own. They will be selling their present home, which is fully paid for, in time to repay their construction loan in full upon completion of the new house. We are gifting them the land, and will be on the deed as co-owners. Can the construction loan be in both names, and will lenders allow us to pay it back 100% ? The new house will be much smaller than the old one, so equity is not an issue.

    • buildingadvisor says:

      While mortgages of this type are common – for example, when a parent “co-signs” a loan — whether you can get a construction loan this way is less clear and will depend on the policies of the individual bank. Construction loan policies vary a lot from bank to bank, so your best bet is to sit down with a loan officer at a couple of banks that you already have a relationship with. Explain what you are trying to achieve and what the options are.

      If I understand you correctly, you will jointly hold the land deed, but it’s not clear whether you will also be co-owners of the house. Regardless, it is possible for more than two people (related or unrelated) to apply for a mortgage or construction loan.

      In fact, three or four people can sign a joint mortgage loan that only one or two of the people will own – or all four may own the property as joint tenants. Everyone who signs the loan will be equally responsible to pay it back, while the owners of the home and the land would be the ones at risk for losing the property to foreclosure.

      The advantage to the weaker borrowers is that they can benefit from the higher income and higher credit scores of the stronger borrows and can usually borrow more money on better terms. However, the people with stronger credit ratings risk seeing their ratings deteriorate if there is trouble repaying the loan. Another potential disadvantage is that all parties to the mortgage are “equally and severably liable” for the full mortgage amount. The bank will go after whoever has the money regardless of who lives in the home.

      There are further complications if there is a divorce of other disagreement and one or more parties want out before the loan is paid off. This is not easy to achieve without refinancing. Also there are two main types of joint ownership to consider: Joint Tenancy and Tenancy in Common. If you are considering borrowing and possible owning property jointly, you’d be wise to discuss your options and your legal responsibilities and risks with a real estate lawyer.

      Read more on Joint Mortgages.

  7. A few years back I got into a construction loan agreement with Chase. Only the first draw of $50K was made to pay the builder to purchase the land and begin work before he disappeared and filed for bankruptcy. Can I sell the land or is it considered collateral to the loan and therefore linked to it? I have the land title and I am paying regular taxes on it.

    • buildingadvisor says:

      It sounds like the land title passed to you at some point based on the terms of the loan. On some loans, title passes to the owner after a certain percentage of the loan is repaid.

      However, if you are still paying off the loan, then the bank holds the first lien on the land (or the title) and will require repayment in full when you sell the land. If the loan has been paid in full and discharged, then the bank should be out of the picture.

      Before proceeding, I would take a close look at the loan documents and title and speak with bank’s loan officer – assuming you are still paying the loan. They will want to make sure there are no liens against the property related to the bankruptcy. For example, was any preliminary work done on the project that the builder never paid for?

      Regardless, I don’t see why you can’t sell the land and pay off the loan. But first check with the bank and it wouldn’t hurt to run it by a real-estate lawyer. There’s lots of fine print in any bank loan for dealing with these types of situations where things don’t go as planned.

      Best of luck – hopefully the land is worth more now than when you bought it!

  8. I am the homeowner and I have hired a GC. We are about to close a construction loan and begin the draw process. Should I open a bank account just for this project and give my GC access to the funds?
    Should I just give my GC money as he presents itemized need?

    • buildingadvisor says:

      Generally, the bank makes the progress payments directly to the contractor after inspecting the job for completion of each phase of work. The final payment is usually endorsed jointly by you and the bank — a good idea so make sure this is your bank’s policy. This gives you some leverage to make sure the quality of the work is acceptable and that all punch list items are completed before releasing the final check.

  9. ron tangen says:

    I think it is a bunch of bull when you are almost complete with a home that will be in the 300k + range and you are 90% complete and cant get a loan to finish because you paid cash for everything to get to that 90% complete. You would think that that would be an asset to the bank !!!

  10. Cathy cox says:

    We are building a new home that unfortunately went into receivership,we contacted our lender who advised us to let them know before the interest only on our loan came to an end,we did this 6 weeks before that date and we were advised by the bank that we were given another 2 months on intrest only,but now they have taken full payments for interest and principle and said we have to apply for funds to finish our home which has now been taken over by another builder,is there anyway we can reverse this? As for 1 we had contacted them and seconds we are paying rent on top of this mortgage,all due to no fault of ours!! Cath cox



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