Construction loans are short-term (12-18 months) interest-only loans that fund draws to your builder during the build, then convert (on one-close products) or get paid off by a new permanent mortgage (two-close). You pay interest only on drawn funds, which start small and grow through the build. The complexity — and cost — comes from the two-stage structure.
Worked example: $120,000 land + $380,000 construction + 10% contingency = $550,000 total. 20% equity ($110K down / land equity) = $440,000 construction loan. Over 12 months, draws average 50% outstanding = $220,000 average balance × 7.75% = $17,000 in interest carry. After final draw, loan converts to a 30-year fixed permanent mortgage.
One-close vs two-close
- One-close (C2P, construction-to-permanent): single closing, single set of fees, rate locked up front. Best for most borrowers. Slightly higher rate than standalone permanent.
- Two-close: construction loan closes, then a brand-new permanent mortgage closes at certificate of occupancy. Two sets of closing costs. Lets you shop the perm rate separately — beneficial only if you expect rates to fall significantly during construction.
Budget components
- Land — 15-25% of total in most markets
- Hard costs — foundation, framing, mechanical, finishes. 65-75% of total.
- Soft costs — permits, architect, engineering, surveys. 5-10%.
- Contingency — 10% minimum. 15% on custom/complex.
- Interest reserve — budgeted interest-only payments during build. Financed into the loan on one-close products.