Construction Loans for a Custom Home: How They Work

Construction-only loans

These loans are short-term loans designed to cover the cost of building a new home. The funds are disbursed in stages as the construction progresses. You will need strong credit and a down payment of 20% to 25%. The specific down payment requirement is determined by the cost of the land and planned construction. If you already own the land, you can use it as equity for your construction loan. To learn more about building your dream home with flexible financing options, visit Keel Custom Homes — your trusted Custom Home Builder in Virginia.

Construction-only loan details for building a New Home

Construction-to-permanent loans

These loans cover the cost of building a new home, but they also convert into a traditional mortgage once the construction is complete. This means that you won't have to go through the process of getting a new mortgage once your home is built.

Some lenders provide a one-step loan that is interest only while the house is being built and then converts to a mortgage once construction is finished. The advantage is that you will have to pay closing costs only once. Some lenders, however, prefer a less risky two-step process. This requires you to take out an interest-only loan for construction and then refinance into a regular mortgage when the house is completed.

Owner-builder construction loans

These loans are designed for people who want to act as their own general contractor and oversee the construction of their own home. Owner-builder loans typically require more documentation and have stricter qualification requirements than other types of construction loans.

Renovation loans

If you're renovating an existing home or planning to add onto your current home, a renovation loan can help cover the cost of the project.

Home equity loans or lines of credit

If you already own a home, you may be able to use your home's equity to finance the construction of a new home. A home equity loan or line of credit can provide a lump sum of cash or ongoing access to funds, respectively.

It's important to note that the availability and terms of these loans can vary depending on the lender and your specific financial situation. It's always a good idea to shop around and compare options before committing to a loan.

What is a construction-to-permanent loan?

A construction-to-permanent loan — often shortened to C2P, or called a one-time close — is a single loan that funds the build and then becomes your mortgage when the house is finished. You close once, at the start. There is no second application, no second appraisal, and no second set of closing costs when construction ends.

That last point is where most of the value sits. With a construction-only loan you are effectively agreeing to refinance in twelve months' time, at whatever rates and whatever underwriting standards exist then, with your own finances re-examined from scratch. A one-time close removes that uncertainty at the cost of slightly less flexibility.

One closing or two: what actually differs

The two structures look similar on paper and behave very differently in practice.

• Closing costs. Two closings means two sets of origination fees, title work, and recording costs. On a mid-six-figure build that difference is rarely trivial.
• Rate risk. A one-time close usually lets you lock a rate before construction begins, sometimes with a float-down option if rates fall. With a construction-only loan you carry the market risk for the whole build.
• Re-qualification. A construction-only loan requires you to qualify again at the end. A change of job, a new car loan, or a shift in lending standards can complicate a refinance that everyone assumed was routine.
• Flexibility. Construction-only borrowers can shop the permanent mortgage on the open market at the end, which occasionally beats the rate their construction lender would have offered.

How the money actually reaches the builder

Construction financing is not handed over in a lump sum. Funds are released in draws — instalments tied to completed stages of work, typically something like permits and site work, foundation, framing, mechanical rough-in, drywall, and completion.

Each draw is usually preceded by an inspection confirming the work is genuinely finished, and the lender may require lien waivers from subcontractors before releasing funds. This is a protection for you as much as for the lender: nobody is paid for a stage that has not happened.

During construction you generally pay interest only, and only on what has been drawn so far. Payments start small and grow as the house does. Budget for the fact that you may be carrying this alongside rent or an existing mortgage — that overlap is the part people most often underestimate.

Using land you already own

If you already own your lot, its value can often serve as some or all of your down payment. A lender will typically look at the appraised value of the land against what you paid and what you still owe on it. Land owned outright, or with substantial equity, can materially reduce the cash you need to bring to closing.

This is one of the quieter advantages of building on your own lot: the land is not just where the house goes, it is part of how the house gets financed.

Building before you sell your current home

Most people building a custom home already own one, and the timing question comes up in nearly every first conversation with a lender.

There are three broad routes. You can qualify to carry both properties at once, which depends on your debt-to-income ratio. You can sell first and rent during construction, which is the cleanest financially and the least comfortable practically. Or you can bridge the gap, using a bridge loan or the equity in your current home to cover the down payment until it sells.

Which one is right is a question about your finances rather than about building, and it is worth putting to a lender early — the answer often shapes the timeline more than anything on the construction side does. Keel works with preferred lenders who handle construction financing regularly rather than occasionally, which matters more than it sounds.

What lenders look at

Construction lending underwrites the project as well as the borrower. Expect to provide:

• Plans and specifications — a lender is appraising a house that does not exist yet, so the drawings and finish schedule are the evidence.
• A signed construction contract, usually fixed-price or cost-plus with a defined scope.
• Builder information. Lenders review the builder's licensing, insurance, and track record. An established local builder shortens this considerably.
• A contingency reserve, commonly a percentage of the build cost, held for changes and surprises.
• The usual borrower documentation — income, assets, credit, and existing debt.

The appraisal is done "subject to completion": the appraiser values the finished house from the plans and specs, and the lender lends against that figure.

Questions worth asking before you commit

• Is this a one-time close, or will I need to refinance at the end?
• When can I lock a rate, for how long, and what does an extension cost?
• How many draws are included, and is there a fee per draw?
• Who orders inspections, and how long does a draw take to fund?
• What happens if the build runs past the loan term?
• Can the land I own count toward the down payment?

An answer you do not understand is a reason to keep asking. The mechanics here are not complicated, but they are unfamiliar, and a lender who cannot explain them plainly is telling you something useful.

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