How to Finance Your Home Construction: A Simple Guide

Building your dream home is an exciting journey, but it comes with an important question: How will you pay for it? Financing new home construction can feel a bit overwhelming, especially if you’re more familiar with standard home mortgages. But don’t worry! In this straightforward guide, we’ll break down the basics of financing your home build in the U.S., step by step. By the end, you’ll feel much more confident about securing the funds for your new home.

1. Create a Realistic Budget for Your Home Build

Before you dive into conversations with lenders or banks, it’s essential to have a clear idea of how much your project will cost. Start by putting together a ballpark construction budget based on your home either being built by a general contractor (GC), or with you managing construction as an owner-builder (OB). If you already own the land, you can skip that cost; if not, include the price of the lot. Remember to consider everything: materials, labor, permits, and set aside some extra for unexpected expenses.

Need help estimating your build costs? Check out our home construction cost estimator tool. Simply enter your square footage, location, and quality level to get a rough estimate. This estimate is essential in figuring out how much you need to borrow and determining if the project aligns with your budget.

Remember, Lenders will want to see a detailed budget and construction plan as part of the loan approval process. Showing that you’ve done your homework, with written cost breakdowns and quotes, makes you a more credible borrower. It also helps prevent unfortunate surprises later on—you don’t want to run out of funds halfway through building!

2. Know the Differences: Construction Loans vs. Mortgages

When you’re building a home, a standard 30-year mortgage will not initially be provided. The lender will start with a construction loan to fund the build, which can then convert into a regular mortgage once the house is completed. Here’s the difference:

Construction Loan: This is a short-term loan (typically 6 to 18 months) that gives you money in installments as your house is built. Instead of getting the full amount upfront (like $400,000 all at once), the bank releases funds at each construction stage (foundation, framing, etc.). During this time, you generally pay interest only on the amounts drawn. Keep in mind that construction loans often come with slightly higher interest rates and usually require a larger down payment—often around 20% of the project cost. For instance, on a $500,000 construction budget, you might need to contribute $100,000, with the bank lending you the remaining $400,000. There are specialized programs like FHA construction loans that allow for down payments as low as 3.5%, but these come with their own set of requirements.
Mortgage (Permanent Loan): This is the traditional home loan you’ll use once the house is finished. The lender gives you a lump sum to buy the completed home, which you pay off over time.
Owner-Builder (OB) Financing: An owner who is acting as their own general contractor is called an owner-builder or OB. The OB is responsible for obtaining subcontractor bids, contracting, scheduling and managing the subcontractors, and paying the subcontractors. Portions of the construction work may be done by the OB themselves if they have the skill and their work meets code requirements. As a result, financing for an OB construction build is a specialty market. Home-Cost.com has partnered with OwnerBuilder Loans, LLC., a lender specializing in owner-builder financing and we recommend reaching out to them for your new home financing.

There are two main ways to go about financing:

Construction-to-Permanent Loan (One-Time Close): This starts as a construction loan while you’re building, and when the house is done, it automatically converts into a regular mortgage. The big advantage? You have just one closing and one set of closing costs, and you might be able to lock in your long-term interest rate in advance—helping you avoid surprises if rates climb during construction.
Separate Construction Loan and Mortgage: Alternatively, you can take out a construction loan and then shop for a mortgage once your home is built, essentially refinancing the construction debt into a mortgage. This option gives you flexibility to find the best mortgage deal later but involves more steps, including two closings and potentially two sets of closing costs. Plus, you’ll be a bit exposed if interest rates change dramatically during your build.

Which option should you choose? If you want simplicity and are confident about rates, the one-time-close construction-to-perm loan could be ideal. If you think rates might drop or you want to shop around later, consider separate loans. Just talk with lenders about what they offer—terms can vary widely.

3. Prepare Your Finances for Construction Loans

Construction financing is seen as riskier by banks, so they’ll carefully scrutinize your qualifications. Before applying, make sure your credit score is solid (often 680+ is preferred for construction loans), and try to reduce any excessive debts. Lenders will also look at your debt-to-income ratio to ensure you can handle the loan payments, requiring documentation like income verification and tax returns, similar to a regular mortgage.

Be ready to provide:

House Plans and Specifications: Lenders typically want to review your architectural plans or at least detailed building specs to appraise the “as-completed” value of the home.
Contractor/Builder Information: If you’ve hired a general contractor, the bank may want to vet them—checking their experience, license, and insurance. Some banks are hesitant to lend if you plan to build the home yourself, known as being an owner-builder. While it’s not impossible, you’ll need a strong financial profile or a professional to oversee the project.
Budget and Schedule: Prepare a detailed budget of all costs and a timeline for construction draws. The bank might even ask you to set aside contingency funds. They typically lend up to a certain percentage of the appraised value or cost, whichever is lower (often around 80%).

4. Shop for Lenders and Compare Options

Not every bank or credit union offers construction loans, so you may need to do a bit of searching. Start with institutions you already have relationships with, but also check out local banks familiar with your area. When comparing lenders, be sure to ask about:

Interest Rates: Find out the rate for both the construction phase and for the permanent mortgage if you opt for construction-to-perm. Construction loan rates might be adjustable, so clarify this.
Fees: There may be additional fees for inspections and documentation. Be sure to compare these costs.
Down Payment Requirements: Some lenders may accept as little as 10% down if you have a strong financial profile, while others may stick to the traditional 20-25%. If you own the land outright, many banks will count that as part of your equity toward the down payment. Owner-builder financing may require 30% equity or more.
Loan Structure: Confirm how draws are handled and how interest is billed. Most construction loans bill monthly interest-only payments.

Don’t hesitate to ask questions! This is likely your first construction loan, and there’s a lot to understand. A good lender will guide you through their process, and it’s wise to get pre-approved for a construction loan before breaking ground. This way, you’ll know your budget limit and can finalize your plans accordingly.

5. Consider Other Financing Avenues

While a construction loan and mortgage combo is the standard route, there are other options depending on your situation:

Using Home Equity: If you own your current home (or other property) and have significant equity, you could consider a Home Equity Line of Credit (HELOC) or a cash-out refinance to fund your construction. This option can be simpler, but it does put your current home on the line.
Personal Funds and Staged Building: Some people pay cash for parts of the build, completing it in stages as funds are available. This can help avoid loans altogether, but it does require discipline and may slow down the project.
Builder Financing: In some cases, particularly with larger homebuilders, a builder might finance the construction costs, allowing you to get a regular mortgage when the home is completed.
Special Programs: If you qualify, research VA construction loans (for veterans), which may offer lower or zero down payments, or USDA construction loans for building in certain rural areas.

6. Be Aware of Interest Rates and Payments

During construction, you’re usually only paying interest on the money that has been disbursed, which can keep initial payments small. However, as more funds are drawn, your payments will rise. Be sure to budget for interest in addition to your construction costs, especially if you’re also managing rent or an existing mortgage.

Also, keep an eye on interest rates. If you’re concerned rates will climb before your home is completed, a one-time-close loan might save you money. Conversely, if you think rates may drop, you might choose to take your chances and secure a separate mortgage later. Some lenders even offer options to lock in a rate while allowing for a “float down” if the market improves—be sure to ask!

7. Understand the Draw Process

Once your financing is confirmed and construction begins, you’ll work closely with your lender on the draw process (which is how you get paid). Here’s how it typically works:

You or your builder submit a draw request when specific milestones are reached (like when the foundation is completed).
The bank may send out an inspector or ask for documentation to verify that the work is done before releasing funds.
Payments can be made to you directly or to your builder/subcontractors, depending on the arrangement.

You’ll only pay interest on the cumulative amount drawn, so it’s important to manage these draws carefully to avoid delays and keep your contractors paid on time. If a contractor isn’t paid promptly, work can stop, impacting your overall timeline. Many construction loans involve 4-6 draws, but larger or custom builds might require more frequent draws.

8. Transitioning After Construction

If you opted for a construction-only loan, you’ll need to start securing your permanent mortgage as your home nears completion. The lender will do a final appraisal of the finished home. If everything checks out, the new mortgage will pay off your construction loan, and you’ll transition into regular mortgage payments. Avoid adding any new debts or changing jobs during this time to keep your financial profile strong.

On the other hand, if you used a construction-to-perm loan, the transition will be more seamless, but you may still need to provide updated paperwork.

9. Bonus Tips to Save Money and Stress

Lock in Major Costs Early: If your contractor can pre-purchase key materials upfront, you can shield yourself from potential cost increases. You also assume the risk if you change your mind or the materials are not later needed.
Stay on Schedule: Delays can lead to extra interest payments. Keep an eye on your timeline and communicate with your lender about any concerns.
Watch Out for Overbuilding: Remember, your loan amount will be based on your home’s appraised value. If you invest too much in upgrades beyond what’s typical for your area, you risk a financing shortfall.

Conclusion: Plan Ahead and Build with Confidence

Financing your home construction can indeed feel like a challenge, but it comes down to proper planning and picking the right loan for your needs. Start by clearly understanding your costs with a solid estimate. Then, find the financing option that best fits your budget and timeline—be it a one-time construction-to-perm loan or a different approach.

By setting a realistic budget, working with knowledgeable lenders, and staying organized throughout the build, you’ll pave the way for success. When all is said and done (and the dust has settled), you’ll not only have a beautiful new home, but also a financing plan that you successfully managed.

Good luck on your home building and financing journey! Our tool Home-Cost’s budgeting software is available to help you make informed decisions and keep your project on solid financial ground.

Frequently Asked Questions About Financing Home Construction

Q1: What is the minimum down payment for a construction loan?
Most lenders typically require around 20% down. However, some FHA programs may allow you to put down as little as 3.5%. If you already own the land, that can usually count toward your down payment, which is great news!

Q2: Can I get a construction loan with bad credit?
It’s definitely more challenging since most lenders prefer a credit score of 680 or higher. However, programs like FHA or VA construction loans might have more flexibility with their requirements. If you can, working to improve your credit score first will help you secure better terms.

Q3: Do I make mortgage payments during construction?
During the construction phase, you typically make interest-only payments on the amount that has been drawn so far. Once construction is complete and your loan converts to a mortgage, that’s when you’ll start making full principal and interest payments.

Q4: What happens if my construction project goes over budget?
Most lenders will require you to have a contingency reserve, which is extra funds set aside for unexpected costs. If you end up exceeding your approved loan amount, you might need to cover the difference out of pocket or request additional financing.

Q5: Can I act as my own builder (owner-builder loan)?
Some lenders do allow this, but many are cautious because it can be riskier. If you’re considering this route, you’ll need to demonstrate strong finances, have a solid building plan, and possibly bring in a construction manager to oversee the project.

Q6: How long does it take to get approved for a construction loan?
The approval process can take anywhere from a few weeks to a couple of months. Lenders need to review your credit, income, house plans, budget, and the credentials of your builder before giving the green light.

Q7: What’s the difference between a construction-only loan and a construction-to-permanent loan?
A construction-only loan finances just the construction of your home, meaning you’ll need to refinance into a mortgage later. On the other hand, a construction-to-permanent loan automatically converts into a mortgage once your home is finished, which means you’ll only have one closing and a lot less paperwork.