Understanding construction loans

With existing home inventory remaining tight in many regions, building a new home may be an option more buyers are considering. Construction loans are one way to finance that process, particularly for borrowers who already own land or plan to purchase a lot.

“For the right borrower—someone with patience, a clear plan and strong credit—building can be a great way to create the home you’ve been looking for and can’t find on the market,” said Ryan Bennett, a regional manager with BOK Financial Mortgage®.

What construction loans are and how they work
What they are
Construction loans are short-term loans that fund the homebuilding process. They can be used to build a primary residence or a second or vacation home, but they are not available for investment or income-producing properties. Borrowers must work with licensed and insured builders, and lenders will review the builder’s contract, project budget and plans before approving the loan.

These loans typically:

• Cover costs such as land, site preparation, materials, labor and permits.
• Feature a fixed rate with interest-only payments during construction.
• Allow borrowers to apply whether they already own land or plan to purchase it.

When the land is owned outright, its appraised value may count toward the borrower’s required equity contribution, helping offset upfront cash needs.

What construction loans aren’t
Construction loans are not designed for every project or borrower. They typically cannot be used for:

• Investment or rental properties.
• Manufactured, modular, log, berm or metal homes.
• Remodels, renovations or additions to existing properties.
• Projects managed by self-builders or owner general contractors.

Building with a construction loan
Before construction begins
Borrowers should research local builders, verify credentials and insurance, and visit completed projects. During the approval process, the lender reviews the builder’s contract, proposed budget and schedule of work before establishing the draw and inspection process.

During construction
Once the loan is approved and building begins, funds are disbursed in stages, known as draws. Each draw corresponds to a milestone—such as pouring the foundation, framing the structure or installing the roof—and is released after inspection and approval.

Loan payments are based only on the funds drawn, not on the total loan amount, which helps align payments with the project’s progress.

After construction is complete
Once the final inspection shows the home meets code and the approved plans, the borrower receives a certificate of occupancy. From there, the construction loan either converts to a regular mortgage, or in the case of a two-time close loan, a new loan is opened to pay off the construction loan and move into permanent financing.

Maintaining stable employment and credit throughout the process helps ensure a smooth closing.

Budgeting beyond the loan
In addition to loan payments, borrowers should budget for costs beyond the down payment and standard lender fees. These may include title, appraisal and inspection fees, homeowner’s and builder’s risk insurance, property taxes and costs related to change orders during construction. Planning for these expenses early helps prevent delays and financial strain.

For prospective homebuyers who already own land or who aren’t happy with the homes they see on the market, building a home from the ground up may the right path forward.

“Custom homes take time, but they give you something unique—a place designed for the way you actually live,” Bennett said. “For many people, it’s not just about building a house. It’s about finally building the right home.”