Construction Loans FAQ

A construction loan is short-term financing designed to cover the costs of building a new home or completing major renovations. Unlike a traditional mortgage where you receive all funds upfront to buy an existing home, a construction loan releases money in stages (called draws) as your project reaches specific milestones. Construction loans typically last 12 to 24 months, just long enough to complete the building process. During this time, you usually make interest-only payments on the amount that has been disbursed, which keeps your payments lower while construction is underway. Once building is complete, you either pay off the construction loan or convert it into a permanent mortgage. There are two main types to consider. A construction-only loan requires you to apply separately for a mortgage once building finishes, meaning two closings and two sets of closing costs. A construction-to-permanent loan (also called a one-time-close loan) automatically converts to a traditional mortgage when construction is complete, saving you money on closing costs and simplifying the process. Because lenders cannot use a completed home as collateral during construction, these loans carry more risk for them. This typically means stricter qualification requirements, higher interest rates, and larger down payments compared to conventional mortgages.

Construction loans have stricter qualification requirements than traditional mortgages because lenders take on more risk financing a home that does not exist yet. Most borrowers who qualify have strong credit, stable income, and a solid down payment ready. Credit score requirements vary by loan type. Conventional construction loans typically require a 700 or higher credit score. FHA construction loans may accept scores as low as 580, though most lenders prefer 620 or higher. VA construction loans generally need a 620 minimum, while USDA construction loans look for 640 or above. You will need to demonstrate stable employment and income, usually with two years of W-2s or tax returns. Self-employed borrowers should prepare year-to-date profit and loss statements plus several months of bank statements showing reserves. Lenders want a debt-to-income ratio of 45% or less in most cases (FHA allows up to 43% with some exceptions). Down payment requirements tend to be higher than regular mortgages. Expect to put down 20% to 25% for conventional construction loans. However, FHA construction loans can require as little as 3.5% to 10% down, making them more accessible if you have limited savings but good credit. Beyond your personal finances, lenders will evaluate your building project and your chosen contractor (more on contractor requirements in the next question).

Construction loan requirements fall into two categories: borrower qualifications and project requirements. For your personal qualifications, lenders want to see a credit score of at least 620-700 depending on loan type, a debt-to-income ratio below 45%, two years of employment and income history, and a down payment of 3.5% to 25% depending on the program. You will also need cash reserves to cover unexpected construction costs. Project requirements are equally important. You must provide detailed construction plans including architectural blueprints, a line-item budget, a realistic timeline, and all required permits. Your builder contract should clearly outline the payment schedule tied to construction milestones. In California, your contractor must be licensed through the Contractors State License Board (CSLB). Lenders will verify the license number and require proof of general liability insurance and workers compensation coverage. Most lenders also check your builder's track record, looking for at least two years of experience completing similar projects, good references, and financial stability. Unlicensed or poorly documented contractors can cause your loan application to be denied. Some lenders have their own approved builder lists, while others will evaluate any licensed contractor you choose. Either way, expect the lender to thoroughly vet your builder before approving the loan. Having all your documentation organized upfront (plans, permits, contractor agreements, and financial records) will help the approval process move faster.

The draw process is how construction loan funds are released to pay for your project. Instead of getting all the money at once, you receive disbursements at each major construction milestone. This protects both you and the lender by ensuring work is actually completed before payment is made. Here is how it typically works. Before construction starts, you and your lender establish a draw schedule based on your project milestones. Common stages include site preparation, foundation, framing, roofing, plumbing and electrical rough-in, insulation and drywall, interior finishes, and final completion. When your contractor finishes a stage, they submit a draw request to the lender. This request includes documentation showing the work is complete, such as invoices, receipts, and photos of the progress. The lender then sends an independent inspector to verify the milestone is genuinely complete. If everything checks out, the lender approves the draw and releases funds, usually within 24 to 48 hours after approval. The approval process typically takes about seven business days total, though complex projects may take longer. During construction, you only pay interest on the amount that has been disbursed so far, not the full loan amount. This keeps your monthly payments manageable until the home is complete. Most lenders withhold a percentage of funds (called retainage) until the entire project is finished to ensure all final details and punch-list items get completed properly.

Applying for a construction loan in California involves more preparation than a standard mortgage because lenders need to evaluate both your finances and your building project. Start by gathering your financial documents. You will need two years of W-2s or tax returns, recent pay stubs (last 60 days), six to twelve months of bank statements showing your down payment source and reserves, and a government-issued ID. Self-employed borrowers should also prepare a year-to-date profit and loss statement. Next, assemble your project documentation. This includes your construction plans and architectural blueprints, a detailed line-item budget from your builder, a realistic construction timeline, your signed builder contract with payment milestones, and information about required permits. Your contractor will need to provide their California Contractors State License Board (CSLB) license number, proof of general liability insurance, workers compensation certificates, and references from completed projects. Once you have everything ready, reach out to a lender experienced with construction loans. Not all mortgage companies offer construction financing, so look for one familiar with California requirements and the draw process. During pre-approval, the lender reviews your finances and provides a preliminary loan amount. After you finalize your plans and contractor, you submit the full application. The lender then appraises the project based on its expected completed value, verifies your contractor's credentials, and underwrites your loan. Approval and closing typically take longer than a regular mortgage, often 45 to 60 days, so plan accordingly.