New Construction Mortgage: How the Two-Phase Loan Works

Building a House Isn't a Mortgage — It's Two of Them

Buying a finished home is one transaction: you borrow a lump sum, the seller hands over the keys, and you start paying principal and interest. Building a home is different. There's nothing to borrow against until the house exists, so the lender can't hand you a check for a finished product. Instead, you get a construction-to-permanent loan — one loan with two distinct phases, designed around the fact that your collateral is being built in stages.

The construction phase runs from groundbreaking to certificate of occupancy, typically 6 to 12 months. During that window, the lender pays the builder through a series of draws, and you pay interest only on the amount drawn so far. When the build completes, the loan converts into a permanent mortgage — a standard 30-year fixed, for most buyers — and you start paying principal and interest like any homeowner.

That two-phase structure drives everything else about construction financing: the higher down payment, the interest-only payments, the inspection schedule, and the choice between closing once or closing twice. Here's how it all works, with real numbers.

Phase One: The Construction Loan

The construction phase is a short-term, interest-only loan with a term of 12 to 18 months. The lender advances money to the builder in draws as work is completed, and you pay interest monthly on whatever has been drawn. You don't pay down principal during construction — there's nothing to amortize yet, and the loan balance is expected to be replaced by the permanent mortgage at the end.

Construction loans price higher than permanent mortgages because the lender takes on more risk: there's no finished collateral, the borrower's credit is being stretched over a longer timeline, and builds can stall. In mid-2026, construction loan rates average around 7.25%, roughly 0.5-0.75% above the 30-year fixed average of 6.625%. That premium is the price of the two-phase structure, and it only applies during the build.

Down Payment: Why 20-25% Is the Norm

Construction lenders underwrite to the after-construction value, not the land price or the cost breakdown. They want your equity stake large enough that you're motivated to finish the build even if values dip or costs spike. That's why the standard construction down payment is 20-25% — and why first-time buyers often find resale purchases easier to finance.

There are exceptions. Some lenders offer construction loans at 10-15% down with a higher rate or a higher credit score requirement. FHA and VA construction programs exist (the FHA 203(k) covers renovations, and VA has a one-time-close construction option), but they're niche products that most local lenders don't offer. If your down payment is under 20%, plan to shop specialty lenders or builder-affiliated programs — and know that PMI applies once the loan converts if you're under 20% equity. The PMI calculator shows what that insurance adds to your permanent payment. Your affordability calculation should use the construction down payment, not the resale one.

Phase Two: The Permanent Mortgage

When construction finishes, the loan converts. The balance — the sum of all draws plus construction interest if you financed it — becomes the principal of a standard mortgage, typically a 30-year fixed at the rate you locked at closing. From that point, the loan behaves exactly like any purchase mortgage: principal and interest payments, escrow for taxes and insurance, and the option to refinance later if rates move.

The key benefit of the two-phase structure is that your permanent rate is locked at the start, at the initial closing. If rates rise during your 9-month build, you're protected — your conversion rate doesn't change. If rates fall, you can refinance after closing, subject to seasoning rules. That rate certainty is a real advantage over the alternative, which is financing construction separately and hoping rates cooperate when you shop for the permanent loan later.

Rates are averages as of August 2, 2026 and vary by lender, credit profile, and region. See the current rate guide.

The Draw Schedule: How the Builder Gets Paid

Construction loans disburse in stages because the collateral is built in stages. A typical schedule on a $360,000 construction loan looks like this:

Example schedule; actual draw percentages and holdback amounts vary by lender and state law.

Every draw triggers an inspection. The lender sends a licensed inspector to confirm the milestone is actually complete, checks that no liens have been filed, and updates the title. Inspection fees run $250-$500 per visit, so a 6-draw build adds roughly $1,500-$3,000 in inspection costs on top of everything else. The builder requests the draw, the inspector signs off, and the lender wires funds — usually within 3-5 business days. If work is incomplete or substandard, the draw is delayed until the builder fixes it, which is your protection against paying ahead of progress.

Every draw also requires lien waivers from the builder and, in most states, from the subcontractors paid out of that draw. A lien waiver is a signed statement that the contractor has been paid for the work and gives up any right to file a mechanic's lien against your property. Without waivers, a subcontractor who never got paid can file a lien on your home months after the draw — and that lien clouds your title and can stall the conversion into your permanent mortgage. Your closing attorney or the lender's title company handles the paperwork, but you should know why every draw request is accompanied by a stack of signed waivers: it's the system that keeps your title clean through the build.

The Math: Interest-Only Payments During the Build

During construction you pay interest on the drawn balance only. That's the detail that surprises most buyers — you're not paying interest on the full $360,000 from day one. Early in the build, when only the foundation is done, your interest bill is small. It grows as draws accumulate.

Here's a month-by-month model for that $360,000 loan at 7.25%, assuming draws happen roughly monthly across a 12-month build:

• Month 1 ($36,000 drawn): interest ≈ $217
• Month 2 ($108,000): ≈ $653
• Month 3 ($180,000): ≈ $1,088
• Month 4 ($252,000): ≈ $1,523
• Month 5 ($306,000): ≈ $1,849
• Months 6-12 ($360,000): ≈ $2,175 each

Add it up and the build costs roughly $22,500 in construction interest. Some lenders let you roll that interest into the loan balance rather than billing you monthly — attractive for cash flow, but it means your permanent mortgage starts at $382,500 instead of $360,000, which raises your payment by about $140 a month at 6.625%. Run the trade-off through the TruePITI calculator before you decide: paying interest monthly is usually cheaper over the life of the loan.

Closing Twice: The Two-Time Close Option

Not every construction loan converts. Some buyers use a stand-alone construction loan, pay it off when the build finishes, and then take out a separate mortgage — the "two-time close." It's more expensive and more risky, but it has one genuine advantage: you can shop the permanent rate at the end of the build instead of being locked in at the start.

Cost estimates based on typical closing-cost ranges as of August 2, 2026.

The closing-twice math is stark: two applications, two credit pulls, two appraisal bills, two sets of title work. On a $450,000 build, one-time close saves you roughly $6,000-$10,000 in fees, plus the risk that your second application runs into a changed financial situation — a job change, a new car loan, a dip in your debt-to-income ratio — and the permanent loan gets harder or pricier. The one-time close is the right default for most buyers. Two-time close only wins if you have a strong conviction that rates will fall meaningfully by the time you're ready for the permanent loan, and even then, the savings have to beat the extra fees.

What You Need Before You Apply

Construction lenders ask for everything a normal mortgage requires, plus a construction package:

• Signed build contract with a licensed, insured builder — the lender will vet the builder's track record, so a handshake deal with a friend won't fund.
• Detailed plans and specs that match the contract price; the appraisal is based on these.
• Proof of funds for the down payment plus reserves — many lenders want 6 months of mortgage payments in reserve, on top of the 20-25% down.
• Cash for cost overruns — plan a 5-10% contingency, because the loan amount is capped and change orders come out of your pocket.
• A rate lock decision — construction rate locks run 12-18 months and cost more than standard 30-90 day locks; your loan officer can quote the trade-off.

Your credit profile matters more here than in a resale purchase, because the lender is underwriting a two-year commitment with construction risk on top of credit risk. A 700+ score and a clean underwriting file will get you the best construction rate. If you're borderline, consider improving your score before applying — the credit score guide shows where you need to be.

The Land Question: Own It Before You Build

Land changes the construction loan math in ways buyers discover late. If you already own the lot free and clear, its appraised value counts as your equity — a $90,000 lot can satisfy most or all of your down payment on a $450,000 build, which is how many buyers build with surprisingly little cash at closing. If you're buying the land as part of the deal, the land purchase price rolls into the construction loan, and your down payment is calculated against the total project cost: land plus construction.

The land itself needs to pass muster too. Lenders want to see that the lot is buildable — zoning allows a home, utilities are available or budgeted, and the soil and drainage support a foundation. A raw lot with no utilities can add $20,000-$50,000 to the project before the first hammer swings, and that money comes from your contingency. Before you fall in love with a lot, have your builder or a local engineer confirm the three utility questions (water, sewer or septic, power) and the setback rules. The appraisal covers this, but you want to know before you pay for the appraisal.

One more land detail: the land-to-value ratio. Lenders generally want the land worth no more than about 30-35% of the total project value. A $250,000 lot with a $200,000 house fails that test at most lenders, because a land-heavy project leaves too little collateral tied up in the structure. If you're building in an area where lots are expensive, talk to your lender about the ratio before you commit — some will flex it, most won't.

Rate Locks and Construction Timelines

Standard mortgage rate locks run 30 to 90 days. Construction locks run 12 to 18 months, because that's how long your build will take — and the longer lock costs more. Lenders charge lock fees and higher rates for extended locks, and the cost grows with the lock period: a 12-month construction lock typically runs 0.5-1% more in points or rate than a 90-day lock on the same loan. That's the price of certainty, and most buyers pay it, because the alternative — floating the construction rate and hoping — leaves your permanent loan exposed to whatever rates do mid-build.

A few lenders offer float-down options on construction locks: if rates drop meaningfully during your build, you can re-lock at the lower rate for a fee. Float-downs cost extra upfront, and the trigger thresholds vary — some require a 0.25% drop, others 0.5%. If you're building in a falling-rate environment, the float-down is worth quoting. If rates are flat or rising, skip it and keep the cash.

Timing matters as much as the lock. Construction loans typically require the build to finish within 12 months, and most lenders charge extension fees if you run over — commonly 0.25-0.5% of the loan for each extra month, plus renewed inspections. A 9-month build with a 12-month loan gives you three months of slack. A build that starts slow, hits weather delays, and runs to 14 months is paying extension fees on top of everything else. When you set the construction timeline with your builder, add a month of buffer to the lender's deadline, not the other way around.

Builder Financing: The Alternative Path

Big production builders — the ones selling entire neighborhoods — often offer their own financing through a captive lender. Builder financing can include attractive incentives: rate buydowns, closing-cost credits, or appliance packages. The trade-offs are real, though. The builder's lender is motivated to keep the deal alive, so their appraisals tend to confirm the builder's price, and the incentives are baked into the margin somewhere — usually the base price or the rate.

The disciplined approach: get pre-approved with an independent lender and quote the builder's program, then compare total costs — price, rate, fees, and incentives — side by side. If the builder's offer genuinely beats the market after you price the same loan terms, take it. Just don't let a $5,000 appliance credit distract you from a rate that's 0.5% higher than the market on a $360,000 loan — that difference costs about $115 a month, over $41,000 across 30 years. The refinance guide covers what to do if you take builder financing and rates move in your favor later.

Bottom Line

A new construction mortgage is a two-phase loan: interest-only construction financing while the house is built, then an automatic conversion into a permanent mortgage. It costs more upfront — 20-25% down, higher construction rates, inspection fees, and a contingency fund — and it pays off in rate certainty and a single closing. If you're weighing a build against a resale, price the construction route with the TruePITI calculator using your real draw schedule, and compare it against buying existing inventory at today's rates. The structure is more complex, but for buyers who want a specific home in a specific spot, it's the only way to finance it.

Frequently Asked Questions About New Construction Loans