You’ve decided you want to build a custom home. Maybe you already own the land. Maybe you’re still looking. Either way, it’s time to talk about how you’re going to pay for it. That’s usually when the term construction loan enters the conversation.
If you’ve purchased a home before, you have an idea of how a mortgage works. Construction financing is different because we’re asking a bank to finance a home that doesn’t exist yet. That sounds complicated, but it isn’t once you understand what the bank is trying to accomplish.
I’ve been building custom homes for more than 40 years, and one thing I’ve learned is that people make better decisions when they understand the process before they’re in the middle of it. So, I’m here to explain construction loans the same way I would if we were sitting down together to talk about your home.
One thing I do want to make clear upfront: Diyanni Homes builds homes. We don’t make loans. Your lender determines your interest rate, credit requirements, down payment, reserves, fees, and underwriting requirements. Those details vary depending on the lender, loan program, and your financial situation.
What Is a Construction Loan?
A construction loan is financing used to pay for building your home. Instead of the bank releasing the entire loan amount at closing, the money is generally released in stages as construction progresses.
The Consumer Financial Protection Bureau explains construction loans as short-term financing used to build or rehabilitate a home, with money commonly advanced during different stages of construction.
Here’s the easiest way I know to explain it. If you buy an existing house for $600,000, there’s already a $600,000 house sitting there. The lender can have it appraised, approve the mortgage, close the loan, and the seller gets paid.
If we’re building you a $600,000 house, that house isn’t sitting there yet. On day one, we might have a piece of land and a set of plans. So the bank doesn’t hand us $600,000 on excavation day. The money follows the construction of the house.
How Does a Construction Loan Work?
The process starts long before we break ground. You’ll work with us to establish a realistic budget, develop or modify your floor plan, evaluate your land, and determine what you’re actually building. Your lender will look at your finances, but they’ll also need information about the project.
That typically includes your property, construction contract, plans, specifications, builder information, and project costs. Then there’s an appraisal. This is where people usually ask me, “Ray, how do they appraise a house that isn’t built?” Good question.
The appraiser uses the plans, specifications, property information, and other details to estimate what the completed home should be worth. Once the loan closes and construction starts, the lender begins releasing money through draws.
A construction draw is simply a portion of the loan being released as work is completed. The lender may inspect the home before approving the next draw.
On our projects, we typically see about five to six draws, although every lender has its own process. So, if you have a $600,000 construction loan, we don’t receive $600,000 upfront. The lender releases portions of that money as the home progresses. That’s really the basic concept.
What Do You Need to Qualify for a Construction Loan?
There isn't one universal set of construction loan requirements. Different banks and loan programs establish different underwriting standards. That's why I'm cautious whenever I see an article telling every reader that they need one particular credit score or one specific down payment.
Your lender needs to answer those questions. In general, though, expect the lender to review your financial qualifications and the proposed construction project.
On the borrower side, that can include your income, employment, credit history, existing debts, assets, cash available for the project, and any equity you already have in the property.
On the construction side, expect questions about the builder, property, floor plans, specifications, contract, project budget, and anticipated completed value.
If you're planning a custom home, I recommend speaking with a construction lender before designing a house around a budget you've never actually confirmed. That's the same advice I give buyers about working with their builder.
I've seen families spend thousands of dollars developing architectural plans only to learn later that the cost of building the house doesn't align with their financial goals. Getting the builder, lender, designer, and homeowner talking earlier gives everyone a much clearer target.
What Documents Will a Construction Lender Ask For?
Your lender will give you the definitive list, but don't be surprised if financing a custom home requires considerably more documentation than buying an existing one.
You could be asked for documents related to your personal finances along with your construction contract, plans, specifications, property, title, project budget, and builder.
This is one area where working with a builder experienced in construction helps a lot. We also have preferred loan officers who specialize in new-construction financing and understand the documentation and timelines associated with custom home construction. You're not required to use a preferred lender, but working with someone familiar with construction loans makes the process easier to understand.
How Does a Construction Loan Appraisal Work?
This question usually makes first-time builders pause: How does someone appraise a house that doesn't exist?
The appraiser evaluates the proposed home using the information available about the project. That means your plans and specifications matter. The lender wants to understand what you're building, where you're building it, and the expected value of the completed property.
Our guide to how long it takes to build a custom home explains why financing is part of the pre-construction timeline rather than something that happens after construction begins. Diyanni's process separates the project into design and land evaluation; selections, engineering, financing, and permitting; and active construction.
Do You Pay a Mortgage While Your House Is Being Built?
Construction-loan payments work differently depending on the lender and loan product. In many cases, borrowers pay interest based on the amount of construction funds actually advanced rather than the entire approved loan balance. Construction funds are generally provided through a series of advances, and those payment structures vary by loan. Here's a simplified example.
Suppose your construction financing totals $600,000. If only $150,000 has been advanced during the early portion of construction, the construction-period interest may be calculated against that $150,000 rather than the full $600,000. As more draws occur, the outstanding balance increases.
Your lender should show you exactly how your particular loan calculates payments, when payments begin, and what happens when construction is completed. Don't leave the closing table without understanding those answers.
Construction-Only vs. Construction-to-Permanent Loans
There are two structures you're likely to hear about.
Construction-Only Loan
A construction-only loan finances the construction period. Once the home is finished, you'll generally need permanent mortgage financing to pay off the construction loan. That means you're dealing with two financing events: construction financing and permanent financing.
Construction-to-Permanent Loan
A construction-to-permanent loan connects the construction financing with the mortgage you'll use after completion. The CFPB specifically notes that some construction loans can convert to conventional mortgage financing, while others require the borrower to apply for another loan.
Government-backed programs can use this structure too. For example, HUD's FHA guidance defines its construction-to-permanent program as combining construction financing with a traditional long-term mortgage through a single mortgage closing before construction begins.
Neither structure is automatically the right choice for every homeowner. Ask your lender about closing costs, rate locks, qualification requirements, construction-period payments, permanent financing, and what happens if the construction schedule changes.
Can You Use Land as Equity for a Construction Loan?
Often, yes. If you already own your homesite and have equity in it, your lender may allow some of that equity to count toward your required contribution.
Suppose your land appraises for $150,000 and you owe $50,000 against it. You potentially have $100,000 in land equity.
That doesn't automatically mean your lender will credit the entire $100,000 toward the transaction. How land equity is treated depends on the lender, appraisal, liens, loan program, and overall financing structure. But it's absolutely worth discussing.
And if you haven't purchased land yet, talk to us before you do. Our guide to buying land to build your dream home explains why a beautiful property isn't necessarily a build-ready property.
Should You Get Pre-Approved Before Designing Your Custom Home?
I strongly recommend getting the financing conversation started early. There's very little benefit in designing a $1 million home if your comfortable total investment is $700,000. I'd rather know the target first.
Then we can talk about the things you absolutely want in your home, the things you'd like to have, and the options we could add or remove depending on their effect on the budget.
That's how we often recommend handling custom features: establish the must-haves first, then price other features as options so you can decide where your money provides the most value for your family.
How Long Does It Take to Get a Construction Loan?
For Diyanni projects, we've found that the construction-loan process often takes around 45 days, give or take. Don't treat that as a guarantee. Your lender, financial profile, appraisal, documentation, property, loan program, and project can all affect the timing. And don't confuse the financing timeline with the entire pre-construction timeline.
Before construction begins, you're also working through the home design and land evaluation, selections, engineering, and permitting. That's why I tell people to ask builders about the entire timeline, not simply how many months it takes to physically construct the house.
When a builder tells you a custom home takes eight or ten months to build, they could be talking only about active construction after everything else is ready.
What Happens If Construction Costs Increase?
This is another question you should ask both your builder and lender before signing anything. With Diyanni Homes, normal material-price increases after the contract is signed are our responsibility. We manage purchasing and supplier relationships, and ordinary cost-of-goods fluctuations are part of our job.
The most common reason a contracted price increases is that the homeowner decides to change something or select an upgrade that wasn't included originally. In those cases, the additional cost is discussed and approved before we proceed.
Our contract also addresses extraordinary market events that create severe disruptions in material pricing or availability. Those situations are rare, but I believe you deserve to understand how your builder handles them before they happen. Your lender should separately explain how change orders or project-cost increases affect your construction financing.
Work With Diyanni Homes to Build Your Perfect Home
If you're considering building on your land in Ohio, Indiana, or Northern Kentucky, start the financing conversation early and bring your builder into it. Schedule a consultation to talk about your property, home, budget, and what needs to happen before you're ready to build.
Construction Loan FAQs
Are construction loans harder to qualify for than mortgages?
They involve additional underwriting because the lender is evaluating both the borrower and a home that hasn't been constructed yet. Requirements vary considerably by lender and program, so ask potential lenders for their current credit, income, debt, reserve, equity, and project requirements.
How much do you need to put down on a construction loan?
There isn't one down-payment requirement that applies to every construction loan. The required contribution depends on the lender, loan program, borrower, appraisal, land equity, and overall project.
Do you need to own land before getting a construction loan?
Not necessarily. Some loan structures allow the land purchase to be incorporated into the construction transaction, while other borrowers already own their property. FHA's construction-to-permanent guidance, for example, permits borrowers either to purchase land at closing or already own it.
What happens to the construction loan when the house is finished?
It depends on the loan. A construction-to-permanent product transitions into long-term mortgage financing, while a construction-only loan generally needs to be paid off with separate permanent financing.