Understanding the Construction Loan Process: How It Works from Start to Finish

Financing a new home build is very different from buying an existing one. Traditional mortgages won’t cover a home that doesn’t yet exist — that’s where construction loans come in. These short-term loans finance the building process and later convert into a standard mortgage once the home is complete.

In this article, we’ll walk through the full construction loan process, covering key stages, loan requirements, and how the draw schedule works. Whether you’re a first-time builder or looking to upgrade, this guide will help you prepare with confidence.

What Is a Construction Loan?

A construction loan is a short-term loan used to finance the building of a new home or major renovations. Unlike a typical mortgage, which pays out the full loan amount at closing, construction loans disburse funds in phases — known as “draws” — as construction progresses.

Once the home is finished, most construction loans convert into a traditional mortgage through a construction-to-permanent loan, or require the borrower to apply for a new mortgage through a two-close structure.

How Do Construction Loans Work?

Construction loans work in a sequence of stages, each tied to progress on the build. You only pay interest on the disbursed amount, not the full loan value, during the construction period.

Here’s how the typical construction loan process works:

1. Pre-approval and planning – Lender evaluates credit, income, and proposed project.

2. Appraisal and project review – Plans, specs, builder approval, and cost estimates are submitted.

3. Loan closing – Once approved, the loan closes and the project begins.

4. Draw schedule begins – Funds are released in installments as construction hits key milestones.

5. Final inspection and conversion – Upon completion, the loan converts into a permanent mortgage (or you close on a new one).

Construction Loan Requirements: What Lenders Expect

Construction loans come with a higher level of scrutiny compared to traditional mortgages. Here’s what lenders typically require from both borrowers and builders:

Borrower Requirements

• Credit Score: Most lenders prefer a credit score of 680 or higher. Some may consider scores as low as 620, but with stricter terms or higher down payments.

• Down Payment: Typically between 10%–20%. VA and USDA construction loans may offer lower or even zero down options if you qualify.

• Debt-to-Income Ratio (DTI): Ideally under 45%. Your lender wants to ensure you can afford both the interest-only construction period and the long-term mortgage.

• Savings Reserves: Lenders often require several months of reserves in case of delays or unexpected costs.

• Experience: Owner-builders may face more hurdles; most lenders require you to work with a licensed, approved contractor.

Builder Requirements

• License and Insurance: Your contractor must be properly licensed and insured in the state where the build occurs.

• Experience Track Record: Many lenders require proof of completed projects similar in scope and size.

• Approved Budget and Plans: Lenders review your architectural plans and a detailed cost breakdown (called a “builder’s packet”) before approving your loan.

• Draw Schedule Agreement: The contractor must agree to a phased payment structure that aligns with inspections and progress.

By meeting these requirements, you’ll avoid unnecessary delays and increase your chances of loan approval—and a smoother construction process.  If you’re unsure whether you qualify, use our Loan Compass tool to estimate your borrowing capacity and evaluate your loan options.

Construction Loan Draw Schedule: How Funds Are Released

Unlike mortgages that disburse everything at closing, construction loans operate on a draw schedule. These draws correspond to specific stages in the build, such as:

Before each draw is released, an inspector or appraiser visits the site to confirm that the required work has been completed. The builder is then paid directly from the lender’s disbursement.

Lenders will not release funds ahead of progress, so delays in inspections or construction can delay payments.

One-Time Close vs. Two-Time Close Construction Loans

There are two ways your loan can be structured:

One-Time Close

You close on the construction and permanent mortgage at the same time. Once construction ends, the loan automatically converts to a standard 15- or 30-year mortgage. This saves on closing costs and reduces paperwork.

Read more: About One-Time Closing Loans 

Two-Time Close

You get a construction loan, then apply for a new mortgage once the build is complete. While this structure offers more flexibility in choosing your long-term mortgage product, it does involve two closings and additional fees.

Pros and Cons of Construction Loans

Understanding the benefits and tradeoffs can help you prepare for a smoother experience.

Pros:

• Interest-only payments during construction

• Tailored to your build timeline

• Often converts automatically into a mortgage (one-time close)

• Can include land purchase

Cons:

• Higher credit and down payment requirements

• Time-consuming paperwork and inspections

• Interest rates may be slightly higher than traditional mortgages

• Budget overruns or delays can create stress or additional costs

Real-World Example: Building the Mitchells’ Dream Home

To better understand the construction loan process, let’s walk through a simplified example of how one family navigated the journey:

Background:

James and Erika Mitchell wanted to build a 2,400-square-foot home on a lot they purchased in Asheville, North Carolina. They chose a one-time close construction-to-permanent loan through a regional lender, avoiding the need to refinance after construction.

Loan Details:

• Loan Type: One-time close construction loan

• Total Loan Amount: $480,000

• Interest Rate During Construction: 6.75% (interest-only)

• Term After Conversion: 30-year fixed at the same rate

• Down Payment: 10%

Draw Schedule Milestones:

1. Land purchase – $60,000

2. Foundation – $40,000

3. Framing & roofing – $120,000

4. Mechanical systems – $90,000

5. Interior & finishes – $100,000

6. Final inspection – $70,000

Key Challenges:

• Their original contractor delayed the framing phase by two weeks.

• The lender required an updated inspection before releasing the next draw.

Outcome:

The home was completed in 8 months. The Mitchells only paid interest during construction and transitioned directly into their 30-year mortgage after receiving the certificate of occupancy.

This type of real-world example helps highlight the benefits of draw schedules, working with experienced builders, and choosing the right loan structure from the start.

How to Prepare for the Construction Loan Process

Before applying, take these steps to strengthen your application:

• Get prequalified and know your budget
  → Use our Loan Affordability Calculator to determine how much house you can safely afford.

• Choose a reputable builder who has worked with lenders before

• Gather your construction contract, plans, and timeline

• Prepare for delays: weather, permits, and material shortages can all affect the draw schedule

• Consider adding a buffer (5–10%) to your budget for unexpected costs

Frequently Asked Questions