A construction loan finances the building of a new home. Funds are released in stages, and the loan is typically converted to a permanent mortgage after completion.
Key Characteristics
Short-term loan for building a home
Funds paid in phases (draws)
May convert to standard mortgage after build
Higher rates and more oversight than traditional loans
Loan Types
Construction-to-Permanent
Converts automatically to a mortgage when building is done.
One-time closing
Stand-Alone Construction
Separate construction and permanent loans.
Two closings required
Credit Score Requirements
Minimum Score:
680
Recommended: 700+ preferred
PMI Impact: PMI may apply depending on mortgage phase
Down Payment Options
Minimum: 20% often required
Typical Range: 20%–30%
No PMI Threshold: 20% or more
Private Mortgage Insurance (PMI)
Required If: Applies in permanent phase if under 20%
Cancellation Point: 80% LTV rule applies
Cost Factors: Standard PMI calculations
Debt-to-Income Ratio
Typical Maximum: 45%
Builder approval and budget also required
Documentation Requirements
Builder plans and contract
Permits and budget
Income and credit verification
Loan Terms
Common Terms:
12–18 months (construction phase), 15–30 years (mortgage phase)
Rate Types: Variable during construction , Fixed after conversion
Best For
Buyers building custom homes
Experienced borrowers with land
Pros
Custom home control
Possible one-time closing
Flexibility in design
Cons
Complex approval and inspections
Higher interest during construction
More paperwork and oversight
Summary
Construction loans allow buyers to build new homes with staged funding and future mortgage conversion. They offer control but require careful planning and approval.