Financing a new home is not the same transaction as buying an existing one. The money does not arrive as a single check at closing. Instead, funds are released in stages as work is completed, and the loan itself ends when the house is finished and converts into permanent financing. For anyone planning a custom build, understanding how this process works prevents surprises at the bank counter.
Before applying, it helps to know what the loan will actually pay for. A new build consumes everything from framing lumber to finish hardware, and the equipment used on site is part of the story. A practical rundown of 40 construction tools shows the range of gear a crew depends on, which explains why materials and equipment make up such a large share of the total budget.
This article walks through how construction loans work, how they differ from conventional mortgages, what they cost, and how to pick a lender that understands custom building, with special attention to log and timber homes.
How a Construction Loan Works
A construction loan is a short-term loan, usually six to 18 months, that covers the cost of building a home. The short term reflects the nature of the work: a build moves in discrete stages, and the lender wants the ability to stop advancing money if the project stalls. The lender does not hand over the full amount at once. It releases money in periodic disbursements, called draws, and each draw is funded only after a qualified third party inspects the site and verifies the percentage of completion. That sequence protects the bank, the borrower, and the builder.
The draw schedule follows the construction project life cycle: site preparation, foundations, framing, the building envelope, mechanical systems, interior finishes, and final inspection. Each phase has a target completion date, and the inspector’s report confirms that the work actually happened before the next payment is authorized.
- Site work and excavation
- Foundation and slab
- Framing and roof
- Windows, doors, and exterior cladding
- Plumbing, electrical, and HVAC rough-in
- Interior finishes and trim
Borrowers pay interest only on the money that has been disbursed, not on the full approved amount. In the early months, when draws are small, the interest bill is small. It grows as the project does. The exact milestones vary by lender, but the pattern is stable: the lender never advances money for work that has not been inspected and verified.
Draw Schedules and Third-Party Inspections
The draw schedule is written into the loan agreement at closing. A typical schedule might release 15 to 20 percent at foundation, 25 percent at framing, and hold the final 10 percent until completion. The exact percentages vary by lender and project, but the logic is consistent: money follows verified progress. Borrowers should expect a site visit before every draw, including the small ones.
A Typical Draw Sequence
- Initial disbursement after the permit is issued and site work begins
- Foundation inspection and release
- Framing and roof inspection and release
- Rough-in inspection for plumbing, electrical, and HVAC
- Interior finish inspection
- Final inspection, followed by conversion to permanent financing
Who Performs the Inspection
Inspectors are independent third parties, not employees of the builder or the borrower. They measure progress against the approved plans and the schedule, then send the report directly to the lender. If a phase is incomplete or defective, the draw is delayed until the work is corrected. Borrowers should attend these inspections; the inspector’s report is the clearest picture of how the project is actually going.
The same structure operates at every scale of development. The $42.5 million construction loan secured for Block 6 at the Waterfront Vancouver project, arranged through U.S. Bank, released funds in stages tied to construction milestones rather than as a single payment. Large commercial towers and single-family homes share the same rule: the lender pays for completed, inspected work.
Construction Loan vs Conventional Mortgage: Key Differences
The differences between the two products show up in term length, how money is disbursed, how interest is charged, and what happens at the end of the loan.
| Feature | Construction loan | Conventional mortgage |
|---|---|---|
| Loan term | 6 to 18 months | 15 to 30 years |
| Disbursement | Draws tied to inspections | Lump sum at closing |
| Interest | Paid monthly on the disbursed balance | Paid monthly on the full principal |
| Collateral | Land and the project in progress | The completed home |
| Interest rate | Usually one to two points higher | Usually lower |
| End of term | Converts to permanent financing or is paid off | Continues across the full amortization schedule |
The conversion step matters. Many construction loans automatically roll into a permanent mortgage when the final inspection passes, a setup called construction-to-permanent financing. Others require a separate mortgage application. Borrowers should confirm which type they are getting before signing, because a second application means a second credit check, appraisal, and set of closing costs.
Project type also shapes the financing picture. A single-family build and a commercial project move through different approval paths, code requirements, and inspection regimes, just as commercial construction differs from residential construction in materials, timelines, and risk. Lenders price each accordingly.
Interest Rates, Down Payments, and Closing Costs
Construction loans carry higher rates than conventional mortgages because the lender holds more risk. There is no finished home to appraise at the start, and the collateral changes value as the work proceeds. Expect the rate to sit one to two percentage points above a comparable permanent loan, often quoted as a variable rate tied to the prime rate. Shop the rate the way you would shop any loan, but weigh it against the lender’s construction experience, because a loan that closes on time is worth more than a slightly lower rate on a loan that does not.
Why the Rate Is Higher
- No completed structure to secure the full balance
- Default risk concentrated in a short window
- Administrative costs of inspections and draw processing
- Exposure to rising material prices mid-project
Down Payment and Cash Reserves
Lenders commonly require 20 percent cash in the project for log and timber homes. The reason is specific to the product: material packages are cut and prepared to exact specifications, so they cannot be returned or resold if the build stops. Lenders also want to see additional cash on hand to cover changes to the original cost estimate, because change orders are normal on custom builds.
The estimate itself depends heavily on material choices. The properties and applications of building materials, from structural lumber to countertops, determine the line items in the budget and how much of each draw goes to suppliers versus labor. Comparing material options before the loan closes produces a more accurate draw schedule.
Qualifying for a Construction Loan
Approval starts like a mortgage application: credit score, debt-to-income ratio, employment history, and asset documentation. What changes is the weight given to the project itself. The lender underwrites the builder almost as heavily as the borrower.
Documentation You Will Need
- Two years of tax returns and recent pay stubs
- Bank statements showing the down payment and cash reserves
- A signed building contract with a fixed price and clear scope
- A detailed cost breakdown and construction schedule
- Proof of land ownership or a purchase agreement
- Approved plans and specifications
Credit requirements are generally similar to a purchase mortgage: most lenders want a score in the mid-600s or higher, a debt-to-income ratio at or below 43 percent, and documented reserves that cover several months of the projected interest payments. Self-employed borrowers should expect extra scrutiny of income documentation.
A licensed, insured builder with a record of completed projects strengthens the application more than almost anything else. So does a realistic schedule. Lenders know that delays add interest cost and risk, and they build that expectation into the rate.
Financing a Log or Timber Home Package
Log and timber homes add a specific wrinkle: the material package. Manufacturers cut and pre-fit logs to exact specifications, and significant deposits are required to reserve a fabrication slot. Full payment to the supplier is due on delivery. At that moment the lender advances funds on an unassembled package whose appraised value will not be realized until the logs are assembled on site. That gap is the biggest risk in the whole loan, and it is why lender experience matters.
Deposits, Delivery, and the Draw Schedule
The delivery itself is a logistics event. Moving prefabricated log sections and oversized components to the site calls for heavy haulage and construction logistics equipment, and the hauling cost belongs in the budget before the loan closes. A lender familiar with timber construction will structure the draw schedule so the package payment lands at the right point and will not penalize the borrower for the gap between paying for the package and its assembled value.
Choosing an Experienced Lender
Ask how many log and timber projects the lender has financed, and ask to see how the draw schedule handles the deposit and delivery payments. A lender who has done this before will know that a large disbursement lands at delivery and will have inspected the process for exactly that moment. A lender without that experience may treat the unassembled package as a problem rather than a normal step in the build.
Site work also depends on machinery, and equipment costs appear across multiple draws. Hydraulic construction equipment, including pumps, cylinders, and power systems, handles excavation, concrete placement, and lifting during the foundation and framing phases, and a good lender expects those line items in the budget. When the loan officer understands the full build sequence, from material deposit to final inspection, financing stops being a hurdle and becomes part of the project plan.