Financing a custom home build is different from buying an existing house. You are not paying for a finished product; you are funding a process that runs six months to a year, with money released in stages as the work is done. The scope of that work, from the construction tools and equipment needed on site to the final finishes, shapes the loan amount, the schedule and the draw plan. Two financing paths exist: separate construction and permanent loans, or a single construction-to-permanent loan that covers both phases.
This guide explains how construction-to-permanent loans work: what the lender requires before closing, how draws and inspections function, what interest you pay during construction, and how the loan converts to a mortgage when the house is finished. It also lays out the costs of the two-loan alternative so you can compare them directly. Most financial institutions offer this package, so ask about it early when you approach a lender.
The Build Timeline and the Project Life Cycle
Construction follows a predictable sequence, and the loan schedule mirrors it. The construction project life cycle phases run from planning and design through site preparation, foundations, framing, mechanical systems and finishes. Lenders expect to see this schedule before they commit funds, because the timing of each stage determines when money will be drawn. A lender that sees buffer weeks built into the schedule prices the risk differently from one that sees a hand-to-mouth timeline.
Why the schedule matters to the lender
A loan officer reads the schedule to understand cash flow: how much will be needed in month one, when the largest draws land and how long the money will be outstanding. Builders who can show a realistic schedule with buffer weeks get smoother approvals than those who promise an aggressive timeline that slips.
Typical milestones for a custom home:
- Design and permits: 2 to 4 months
- Site work and foundation: 1 to 2 months
- Framing and roof: 1 to 2 months
- Mechanical, electrical and plumbing rough-in: 1 to 2 months
- Finishes, fixtures and landscaping: 2 to 3 months
Two Loans or One: Compare the Costs
The obvious alternative to a construction-to-permanent loan is financing construction and the permanent mortgage separately. That means two loans, two qualification processes, two underwriting reviews and two sets of closing costs. Origination fees, appraisal, title insurance and attorney charges repeat, and the second closing happens while you are already paying for the house. For most owners the numbers favor a single closing, which is why the construction-to-permanent loan is the most common construction financing product. Closing costs on each loan typically run 2 to 5 percent of the amount borrowed, so the second closing adds real money to the project.
The process also carries stress that budgets rarely capture. Construction is demanding work, and the industry’s mental health record reflects it: industry groups have united to reduce the suicide rate among construction workers, a reminder that a build plan should protect the people doing the work. Owners who keep realistic schedules, clear contracts and a contingency fund reduce the pressure on everyone involved.
| Item | Two separate loans | Construction-to-permanent |
|---|---|---|
| Closings | Two, each with its own fees | One |
| Closing costs | Origination, appraisal, title and attorney fees twice | Single set of fees |
| Construction rate | Variable, interest-only | Variable, interest-only |
| Permanent rate | Set at the second closing | Lock at closing or set at conversion |
| Qualification | Underwritten twice | Underwritten once |
| Conversion | New loan and new underwriting | Automatic transition with paperwork |
Draws, Inspections and Interest-Only Payments
Construction loans do not hand the borrower the full amount at closing. The lender keeps control of the proceeds and releases them in draws, each tied to completed work. After you submit a draw request, an inspector confirms the work matches the request and meets generally accepted construction standards, then the lender disburses the funds. This protects both sides: the owner pays only for work in place, and the lender avoids funding work that never happens. Knowing the difference between permanent and temporary works at construction sites helps owners review draw requests, because inspectors verify the permanent work installed, not the scaffolding and shoring used to build it.
What you pay during construction
During the construction period you pay interest only, calculated on the drawn balance. Nothing accrues on funds the lender has not released. The rate is usually variable, with the Wall Street Journal Prime Rate as the index plus a margin set by the lender, often one to two percentage points. Because the balance grows as draws are made, the monthly interest payment grows with it. Most lenders cap the construction period at 12 months, with extensions available on request.
The draw request checklist
- Submit the draw request in writing with the amount requested.
- List the work completed since the last draw.
- Attach invoices and lien waivers from the contractors.
- Schedule the lender’s inspection of the completed work.
- Keep receipts for materials stored on site for future draws.
Your own equity comes in first. Lenders fund construction only after the owner invests the required cash or real estate equity, typically 10 to 20 percent of the project cost, and the loan-to-cost ratio rarely exceeds 80 to 90 percent. Owners who can contribute more equity reduce the loan amount and the interest paid on it.
The Conversion: From Construction Loan to Mortgage
When the construction period ends and the certificate of occupancy issues, the loan converts to permanent financing. You begin paying principal and interest according to the terms of the construction-to-permanent obligation, and the monthly payment may include escrow for homeowner’s insurance and property taxes. The permanent rate can be fixed or variable. Some programs let you lock the permanent rate at closing, which protects against rate increases during the build; others set the rate at conversion based on market conditions. Permanent terms typically run 15 to 30 years. Confirm whether the rate lock costs a fee and how long it lasts.
Owners should know their key dates: the end of the construction period and the conversion date. Delays happen, and most lenders will extend the construction period on request, though an extension usually brings paperwork and sometimes a fee. Lenders also underwrite custom residential builds differently from commercial projects, since the risks, timelines and exit values differ; the ways commercial construction differs from residential construction explain why loan terms vary by project type.
Qualifying, Documentation and Budget Contingencies
Qualification for a construction-to-permanent loan starts with the same documents a mortgage requires: income, assets, credit and debt-to-income ratio, plus the building contract, plans, permits and a cost breakdown. The cost breakdown must be realistic, because the lender’s appraiser compares it against local construction costs. Materials eat a large share of every draw, so understanding the properties and applications of building materials helps you price the schedule accurately and avoid change orders that inflate the loan.
Contingency and change orders
Set aside a contingency of 5 to 10 percent of the construction budget. Change orders are the most common source of overruns: a different tile, a bigger window or a moved wall each adds cost and time. Decide at the start who approves changes and how they are priced, and put every change in writing before work begins.
Shop lenders early. Compare the margin over the prime rate, the draw inspection fees, the cost to extend the construction period and whether the permanent rate can be locked at closing. Ask what happens if the appraisal comes in below the contract price, because that gap must be funded from your own pocket or by trimming the scope. A comparison sheet from three lenders takes an afternoon and can save thousands in interest over the life of the loan.
Logistics and the Final Stretch
The last months of a build are logistics. Deliveries of lumber, windows, fixtures and appliances arrive in waves, and each delivery must land when the crew is ready for it. Getting materials and equipment to the site is its own discipline: heavy haulage and construction logistics cover the transport of oversized components, the permits for wide loads and the staging space needed to keep the site organized. Ask your builder who manages deliveries and what happens to materials that arrive early.
When the final draw clears and the loan converts, the paperwork shifts from construction to ownership: the mortgage payment begins, escrow accounts open and the warranty period starts. Keep the closing documents, the draw records and the maintenance list in one file. A construction-to-permanent loan planned around a realistic schedule, a solid budget and clear documentation converts cleanly, and the house is yours without a second round of financing.