New construction loans: how financing a build actually works

Financing a home you haven't built yet works differently from a purchase loan, because the collateral doesn't exist until draws pay for it to get built. The lender has to underwrite the lot, the builder, the plans, and you, all before a single shovel goes in the ground.

Here's the sequence Jesse walks clients through on almost every build: secure or already own the lot, get a signed contract with a licensed builder, have the loan sized against the total project cost, receive funds through a draw schedule tied to inspections, then convert into a permanent mortgage once the certificate of occupancy is issued.

How does a construction loan work step by step?

It starts with the lot. Some borrowers already own it outright, some are buying it as part of the transaction, and some are refinancing land they've held for years. The lender needs a purchase contract or a current valuation on the lot before anything else moves forward.

Next comes the builder contract. This isn't optional paperwork, it's underwriting substance: the lender reviews the builder's license, the fixed-price contract, the plans and specs, and often a budget broken down by trade (foundation, framing, roofing, mechanicals, finishes). A builder who won't sign a fixed-price contract, or who wants cash draws outside the lender's schedule, is a red flag most lenders won't work around.

Once the lot and contract are in hand, the loan gets sized against total project cost, which is lot value (or purchase price) plus total construction cost, not just the build budget alone. From there, the lender releases money to the builder in draws as work is completed and verified by inspection, and at the end, the loan converts to a permanent mortgage without a second full closing.

What's the difference between one-time close and two-time close construction loans?

A one-time close construction loan combines the construction phase and the permanent mortgage into a single closing and a single set of loan documents. You qualify once, at the start, and the loan automatically converts to permanent financing when the home is finished. Most residential construction lending, including FHA's construction-to-permanent product described on the FHA construction pillar, is structured this way.

A two-time close loan splits the deal: you close a short-term construction loan first, then close a second, separate permanent mortgage after the home is done. That means two sets of closing costs and a second full underwrite, but it can give more flexibility if the builder, the plans, or the borrower's situation might change mid-build.

How does the lender size a construction loan?

Sizing starts with total project cost: the lot (owned or purchased) plus the full construction budget from the builder's contract, including a contingency line most lenders require for cost overruns. The loan amount is based on the lesser of total cost or the appraised future value of the finished home, similar to how a purchase loan is based on the lesser of price or value.

Down payment requirements vary by loan type. FHA's construction-to-permanent option allows financing with as little as 3.5% down for qualifying borrowers, per FHA guidelines, which is the same minimum FHA uses for a standard purchase. Conventional construction-to-perm loans typically require more money down, and the exact amount depends on the lender's own guidelines since Fannie Mae and Freddie Mac don't set a single universal minimum for construction lending the way FHA does for its program. Borrowers comparing options side by side often start with the One-Time Close calculator to see how lot value, build cost, and down payment interact before they lock in numbers with a loan officer.

How do draws and inspections work during the build?

The lender doesn't hand the builder a lump sum. Money moves in draws, meaning the builder requests payment for a completed phase of work, an inspector (either the lender's own inspector or a third party) verifies that phase is actually done to the standard in the contract, and only then does the lender release funds for that draw. This protects the borrower as much as the lender, because it means the builder can't get paid for work that isn't there.

Draw schedules are tied to construction milestones rather than a calendar, so a delay in framing pushes back every subsequent draw rather than releasing money on a fixed date regardless of progress. Interest during construction is usually charged only on the funds actually drawn, not on the full loan amount, since undisbursed money hasn't left the lender yet.

What happens when the loan converts to a permanent mortgage?

Once the home passes final inspection and the local building department issues a certificate of occupancy, the construction phase ends. In a one-time close structure, this is where the loan simply converts, the interest-only construction period ends, and the loan begins amortizing as a standard mortgage, with the rate and term that were set at the original closing (subject to any float-down terms the lender offered).

In a two-time close structure, this is where the second closing happens: a new application, a new underwrite, and a new set of closing costs to move from the short-term construction loan into permanent financing. Anyone weighing whether a two-time close is worth the extra cost and paperwork should ask their loan officer directly, because the answer depends on how likely the project is to change mid-build.

Does the loan type change if you already own the lot free and clear?

Owning the lot outright generally helps rather than complicates the file, because the lender can often count the lot's equity toward the down payment or the loan-to-value calculation instead of requiring fresh cash at closing. The lot still needs a current valuation, and the lender will confirm there's no existing lien or judgment attached to it, but a free-and-clear lot is one less moving piece in the transaction.

Borrowers who bought raw land years ago and are now ready to build should bring the deed, any survey, and utility or access information (well, septic, road access) to their first conversation with a loan officer, since those details affect both the appraisal and the construction budget.

Which loan programs actually offer construction financing?

FHA offers a construction-to-permanent option built for owner-occupants, detailed on the FHA construction pillar, and it's the program most first-time or lower-down-payment borrowers land on. Conventional construction-to-perm loans, built around Conventional loan guidelines, work for borrowers with stronger credit and larger down payments who don't need FHA's flexibility. Investors building rental property or small multifamily typically look at Bridge and construction financing instead, since owner-occupant construction-to-perm products aren't built for non-owner-occupied projects. And because a build's total cost can push a loan amount past standard limits, it's worth checking the conforming and FHA loan limits for your county before finalizing a budget with your builder.

A real scenario

A client came to Jesse already owning a lot free and clear, with a signed fixed-price contract from a licensed local builder. The wrinkle was timing: the builder's draw schedule assumed a faster permit turnaround than the county actually delivered, which pushed the framing draw back several weeks. Because the loan was structured as a one-time close with interest charged only on funds actually drawn, the delay cost the client time but not a second underwrite or a second set of closing costs. The home passed final inspection, the certificate of occupancy came through, and the loan converted straight into the permanent mortgage that had been locked in from day one.

Frequently asked questions

Can I use a construction loan to buy the lot and build at the same time?

Yes. Most construction-to-permanent loans finance the lot purchase and the build costs together in one loan amount, based on the lesser of total project cost or the home's appraised future value.

How much down payment do I need for a new construction loan?

It depends on the program. FHA's construction-to-permanent option allows as little as 3.5% down for qualifying borrowers, per FHA guidelines, while conventional construction loans typically require more, with the exact figure set by the lender.

What happens if my builder falls behind schedule?

Draws are tied to completed, inspected work rather than a fixed calendar, so a delay pushes back the draw schedule and the closing timeline rather than triggering a penalty on its own. In a one-time close loan, interest is generally charged only on funds actually disbursed, which limits the cost of a delay.

Do I need to already own the lot before applying?

No, but it helps. You can finance the lot as part of the construction loan, or if you already own it free and clear, the lender can often credit that equity toward your down payment or loan-to-value calculation.

What's the difference between a one-time close and two-time close loan?

A one-time close combines construction and permanent financing into a single closing and one set of documents, while a two-time close splits them into two separate closings with two sets of costs. Most residential borrowers choose one-time close for the simplicity and single rate lock.

Can I use a construction loan for an investment property?

Owner-occupant construction-to-perm programs like FHA and most conventional options aren't built for rental property. Investors building new construction to hold as a rental typically use bridge and construction financing designed for that purpose instead.

Is the interest rate locked before construction even starts?

In most one-time close structures, yes, the rate is set at the initial closing and carries through to the permanent loan, sometimes with a float-down option depending on the lender's terms. In a two-time close structure, the permanent rate is set at the second closing instead.

How do I know how much home I can actually afford to build?

Start by running the lot value, expected build cost, and down payment through the One-Time Close calculator, then confirm the numbers with a loan officer who can factor in your credit profile and the builder's actual contract.

Reviewed by Jesse Gonzalez, NMLS #278103

This article is for general information only and is not a loan approval, rate quote, or financial advice. Program guidelines change and every file is different, so talk to a licensed loan officer about your scenario. True Blue Lending Corporation, NMLS #2380218. Equal Housing Opportunity.