What is a Construction Loan?
A construction loan is a short-term, higher-interest loan that finances the building of a new property or major renovation of an existing one. Unlike standard mortgages that are disbursed as a lump sum, construction loans release funds in stages (draws) as construction milestones are completed. The lender inspects progress before releasing each draw to ensure the work matches the approved budget and plans.
Construction loans typically convert to permanent financing (a standard mortgage) once construction is complete. Some programs (construction-to-permanent or "one-time close" loans) combine both phases into a single loan with one closing, saving on fees and simplifying the process.
How construction draws work
The lender and borrower agree on a draw schedule based on construction milestones. Common draw stages include foundation complete, framing complete, rough-in (plumbing, electrical, HVAC), drywall and interior finishes, and final completion. At each stage, the borrower requests a draw, the lender sends an inspector, and upon approval, the next portion of funds is released. During construction, the borrower makes interest-only payments on the amount drawn.
Construction loan requirements
- Down payment: 20-25% of the total project cost (land + construction)
- Credit score: 680+ for most lenders
- Detailed plans: Architectural plans, specifications, and a detailed construction budget
- Licensed builder: Most lenders require a licensed general contractor (not DIY)
- Timeline: 12-18 months construction period
- Rate: Prime + 1-3% (variable during construction)
Construction loans and investors
For flip investors doing major renovations (gut rehabs, additions), construction loans provide structured financing that covers both acquisition and rehab costs. The draw schedule ensures funds are available as needed without requiring all capital upfront. For ground-up builders, construction loans are essential since the property does not yet exist to serve as collateral for a standard mortgage. Some hard money lenders offer renovation-specific products that function similarly to construction loans but with faster approval and less documentation.