Understanding Construction Loans: How to Finance Your Dream Home

If you’ve scoured the market for months, toured every resale, and still can’t find a house that feels like home, you’ve probably had the urge to build your own. After all, no one can build a home to suit your every need like you can.  Maybe you want a place in Dripping Springs with an open chef’s kitchen and floor-to-ceiling windows overlooking the Hill Country. Or maybe you’re eyeing a new build in Houston with energy-efficient features and space for multi-generational living. Whatever your vision, the right financing is what makes it possible. That’s where construction loans come in.

This guide breaks down everything you need to know about construction loan requirements, how to get a loan to build a house, and the different options available. By the end, you’ll know how to turn a piece of land into your dream home—and why working with a mortgage broker can save you serious time and money in the process.

What Is a Construction Loan?

A  construction loan is short-term financing used to cover the cost of building a home. Unlike a traditional mortgage, where you get a lump sum upfront, construction loans release money in stages—called “draws”—as each phase of the project is completed. That means your builder gets paid as they go, and you only pay interest on the funds that have been disbursed.

Once your home is finished, the construction loan typically converts into a traditional mortgage. That long-term mortgage is what you’ll pay back over 15 to 30 years. What sets construction financing apart is that lenders want to see your plans in detail—blueprints, specifications, and a timeline that shows exactly how the project will come together. Those plans aren’t just for your builder—they give the lender confidence that the home they’re financing will be completed on schedule and within budget.

Construction financing isn’t just one specific loan type. Depending on your goals and situation, there are different loan types available.

Types of Construction Loans

Construction-Only Loan
This loan covers the cost of building and lasts only as long as the construction phase—usually 12 months or less. When the home is complete, you’ll need to apply for a separate mortgage. That means paying two sets of closing costs.

Construction-to-Permanent Loan (AKA One-time Close)
Also called a “one-time close,” this loan starts as a construction loan and then automatically converts into a traditional mortgage once the build is finished. You avoid two closings, save on fees, and lock in your rate up front. Learn more about One-Time Close Loans here.

Owner-Builder Loan
Some borrowers act as their own general contractor. These loans exist, but they’re tough to qualify for. Most lenders will only approve if you have proven experience, licensing, or a strong construction background.

Renovation Loan
If you’re not starting from scratch but want to make major upgrades, renovation loans (like FHA 203(k) or Fannie Mae HomeStyle) allow you to finance the purchase and the rehab costs in one loan.

VA and FHA Construction Loans
VA offers true zero-down one-time close construction loans for eligible service members and veterans, making it one of the strongest programs available. One of the biggest advantages? VA one-time close loans don’t require monthly payments during the build phase, giving military families breathing room while their home is under construction. FHA also has programs that make new construction more accessible for first-time buyers with smaller down payments.

WHY ONE-TIME CLOSE CONSTRUCTION LOANS WIN

One-time close construction loans simplify the process by combining construction and permanent financing into a single package. That means you only apply once, pay one set of closing costs, and can lock in your mortgage rate before the first shovel hits the dirt. You also eliminate the risk of re-qualifying for a separate mortgage at the end of construction—something that can be stressful if rates rise or your financial situation changes mid-build. For many buyers, the predictability and cost savings of a one-time close loan make it the smarter, safer choice. Even better, when your loan converts to a permanent mortgage, it’s based on the then-current mortgage rates. If rates fall during construction, you win—you’ll lock in a lower rate without having to start the process over.

Construction Loan Requirements

Getting a loan to build a house is more complex than a standard mortgage. Here’s what lenders typically look for:

Credit Score: Most lenders want a minimum score of 620, though stronger credit can help you qualify for better rates. Some lenders may look for 680 or higher if you’re financing a large project or acting as your own builder. A higher score can also reduce your interest rate, which matters when you’re making interest-only payments during the build.

Down Payment: Expect to put down at least 20%—sometimes even 25% if the project is more complex. The down payment reassures the lender that you’re invested in the build. VA construction loans are a notable exception, often allowing zero down for eligible borrowers.

Debt-to-Income Ratio (DTI): Lenders compare your monthly debts to your gross income. A lower DTI shows you can handle the extra debt. Most lenders cap DTI around 43%, but stronger borrowers may qualify up to 50% if they have compensating factors like large reserves or an established builder.

Builder Approval: Your lender has to approve the builder. They’ll check licensing, insurance, and past project history. Lenders want assurance that the contractor has completed similar projects successfully and has the capacity to finish on time. Some may even request references or review financials of the builder’s company.

Plans and Budget: You’ll need a signed construction contract, blueprints, a detailed budget, and a payment schedule. The more detailed the documentation, the easier the approval. Lenders want to see line-item costs for materials and labor, and they’ll compare it to the projected appraisal value to make sure the numbers add up.

Insurance: Lenders often require homeowners insurance with builder’s risk coverage before approving the loan. This protects both you and the lender in case of damage, theft, or accidents during construction. Depending on the location, you may also need flood insurance or additional coverage for natural disasters.

How to Get a Construction Loan

The process feels similar to a regular mortgage but with extra steps:

1. Choose a Builder
   Vet contractors carefully. Read reviews, check past projects, and make sure they’re licensed and insured. A reputable builder makes the loan approval smoother. The builder you choose is one of the most important factors in getting approved, so don’t cut corners on due diligence.

2. Get Pre-Approved
   Like a regular mortgage, pre-approval shows what you can afford. It’s based on credit, income, assets, and the scope of your project. Getting pre-approved early also helps you set realistic expectations with your builder about budget and finishes.

3. Submit Your Plans
   Provide blueprints, timelines, and budgets. The lender will review to ensure the project is realistic. The more detail you provide, the smoother the underwriting process.

4. Appraisal and Approval
   An appraiser evaluates the “as-completed” value of the home. If it aligns with the budget, you’re good to go. The lender will then issue formal approval and set up the draw schedule.

5. Draws and Inspections
   Funds are released in stages, often five to seven draws over the life of the project. Each draw requires an inspection to confirm progress, so make sure your builder is prepared for that process. This ensures accountability and keeps the project on track.

6. Conversion to Mortgage
   If you chose a construction-to-permanent loan, it automatically converts. If not, you’ll need to secure a new mortgage. This final step is where your interest-only construction loan turns into a long-term mortgage, locking in your permanent monthly payment.