What is a construction loan?
Answered by AskBaily Editorial · Updated
Short answer
A construction loan is short-term financing (typically 6-24 months) that funds a home build or major renovation in stages tied to construction milestones. Unlike a mortgage, you pay interest only on funds drawn as of each stage. At completion, most construction loans convert to a standard 15- or 30-year mortgage (called a construction-to-permanent or C2P loan).
In detail
Construction loans exist because mortgage lenders don't lend against uncompleted work. The structure addresses two risks: the lender's risk that the borrower might not complete the project, and the borrower's risk of carrying a full mortgage on an uninhabitable asset.
How the draw schedule works:
1. Loan approved for total construction cost plus soft costs. 2. Funds drawn in stages as construction progresses (4-7 draws): - Closing: purchase lot or payoff existing loan. - Foundation complete. - Framing + roof dry-in. - Mechanical rough-in. - Drywall complete. - Final completion + occupancy permit. 3. Inspections before each draw — the lender sends a third-party inspector. 4. Interest only during construction — pay only on funds drawn. 5. Conversion at completion — either the construction loan pays off with a separate mortgage, or a C2P loan automatically converts.
Typical 2026 terms:
- Construction phase: 12-18 months.
- Rate during construction: Prime + 1-2% (7-9% as of Q1 2026).
- Rate after conversion: conventional mortgage rates.
- Down payment: 20-25% typical.
- Loan-to-value: 80-85% of completed appraised value.
Renovation-specific construction loans:
- Fannie Mae HomeStyle Renovation — conventional loan that allows financing repairs and improvements up to the as-completed value.
- FHA 203(k) — FHA-backed renovation loan. Standard 203(k) for major work; Limited 203(k) for under $35,000.
- VA Renovation Loan — eligible veterans.
Construction-only vs C2P:
- Construction-only — two closings. More flexibility if you want to shop permanent rates later.
- C2P (one-time close) — single closing. Lower total fees. Rate locked at construction close.
What the lender requires:
- Detailed cost breakdown from contractor.
- Stamped architectural drawings.
- Contractor's license, insurance, and bond verification.
- Building permits.
- Title insurance.
- Homeowner's insurance including course-of-construction coverage.
Common pitfalls:
- Budget overrun mid-construction.
- Delays triggering loan expiration.
- Contractor changes mid-project require lender approval.
AskBaily's matched contractors are pre-qualified for most major construction lenders in the regions we serve.
Sources
How AskBaily helps
AskBaily scopes your project in one chat — permit flags, cost range, and timeline — then routes you to one licensed contractor whose license we verify live. No shared leads, no racing against seven other bidders, no lead fees to your pro.