How a construction loan differs from a mortgage
A mortgage finances a house that already exists. A construction loan finances one that does not yet, so the lender manages its risk by releasing funds gradually and checking progress along the way.
During construction, borrowers commonly pay interest only on the amount drawn so far, rather than on the full loan. Lenders typically review the builder, the plans, the budget, and the schedule before approving the loan, and they usually rely on an appraisal of the home’s projected value once complete. Terms, rates, and requirements vary by lender, so compare options with a qualified loan professional.
Construction-to-permanent vs. standalone loans
The two most common structures differ mainly in what happens when construction ends.
- Construction-to-permanent — one loan and usually one closing; it converts to a long-term mortgage when the home is complete
- Standalone construction loan — a short-term loan for the build, paid off at completion with a separate mortgage and a second closing
- Renovation loans — some lenders offer products designed for major remodels of an existing home, based on its value after renovation
- Home equity financing — owners with significant equity sometimes fund remodels or additions through a home equity line or loan
How draw schedules work
A draw schedule divides the loan into payments tied to construction milestones. When a milestone is reached, the builder requests a draw, the lender verifies the work, and funds are released.
Typical milestones follow the build sequence: site work and foundation, framing, roofing and windows, rough mechanical, electrical, and plumbing, insulation and drywall, finishes, and final completion. Lenders usually send an inspector to confirm progress before each draw, and some hold back a portion of each payment until the end.
For a smooth project, align the lender’s draw schedule with the builder’s payment schedule before construction starts. A mismatch between the two can leave the builder waiting for funds and the schedule waiting with them.
Plan for contingency and soft costs
Lenders and builders both expect a realistic budget, and the most common gap is soft costs and contingency rather than construction itself.
Soft costs such as design, engineering, plan check, permits, and utility fees commonly add 15 to 25 percent to a Los Angeles construction budget. Contingency of 10 to 15 percent for new construction, or 15 to 20 percent for renovation, should be part of the financed budget rather than an afterthought. Ask your lender how they treat contingency, and whether unused funds reduce the loan at the end.
Schedule affects cost too. Because interest accrues as funds are drawn, a project that runs months longer carries more interest. Finishing selections early and ordering long-lead materials before construction both help keep the schedule, and the financing cost, under control.
What your builder provides to the lender
Lenders typically ask for the builder’s license and insurance, a signed construction contract, a detailed budget or cost breakdown, the plans and specifications, and a schedule. Some also ask for the builder’s experience and references.
A builder who produces a clear line-item budget and a realistic schedule makes underwriting easier and draws faster. SAS Builds provides drawings, a schedule, and a clear price before construction starts, which is the same information a lender needs to evaluate the project.
Questions to ask a lender
Construction lending varies more than standard mortgages, so comparing lenders on process matters as much as comparing them on price. The answers affect your schedule and your builder’s cash flow as much as your monthly payment.
Ask how many draws the loan allows and how quickly inspections and payments happen after a request. Ask whether the lender holds back a portion of each draw until completion, how contingency and soft costs are treated, and what happens if construction runs longer than planned. For construction-to-permanent loans, ask when and how the loan converts, and what is required at that point.
- How many draws are allowed, and how fast are they paid?
- Is a portion of each draw held back until completion?
- How are contingency and soft costs handled?
- What happens if construction runs long?
- When and how does the loan convert to a permanent mortgage?
Frequently asked questions
How does a construction loan work?
A construction loan releases money in stages, called draws, as construction milestones are completed and verified, usually by a lender’s inspector. Borrowers commonly pay interest only on the amount drawn during construction. When the home is complete, the loan either converts to a permanent mortgage or is paid off with separate financing.
What is a construction-to-permanent loan?
A construction-to-permanent loan finances construction and then converts to a long-term mortgage when the home is finished, typically with a single closing. It avoids qualifying and closing twice. A standalone construction loan, by contrast, must be paid off at completion with a separate mortgage.
What is a construction loan draw schedule?
A draw schedule divides the loan into payments tied to construction milestones such as foundation, framing, rough mechanical, drywall, and completion. The builder requests a draw when a milestone is reached, the lender verifies the work, and funds are released. Aligning it with the builder’s payment schedule keeps the project moving.
Does a construction loan cover soft costs and contingency?
Often it can, depending on the lender. Soft costs such as design, engineering, permits, and fees commonly add 15 to 25 percent in Los Angeles, and a contingency of 10 to 20 percent is prudent. Ask your lender how these are included and how unused contingency is handled at completion.
Is this financial advice?
No. This guide explains how construction financing generally works so you can plan a project. Loan products, rates, qualification standards, and terms vary by lender and change over time. Speak with a qualified mortgage professional about your situation before making financing decisions.
