A construction loan finances a house that doesn't exist yet. Instead of funding the whole loan at closing, the lender releases money in stages, called draws, as an inspector confirms each phase of the build is done. During construction you usually pay interest only on what's been drawn so far. When the house is finished, the loan either converts to a regular mortgage (a one-time close, also called construction-to-permanent) or gets paid off by a new mortgage at a second closing (a two-time close). In Texas, homestead and mechanic's lien laws add paperwork that has to be signed in the right order, before any work starts.
A regular mortgage is made against a house that already exists. The appraiser walks through it, the title company insures it, and the lender funds the whole loan at closing. A construction loan is made against a plan. On day one there may be only a lot. The lender is lending against what the house will be worth when it's finished, and it protects itself by releasing money only as the house is actually built. That changes almost everything about the file: what gets underwritten, how the money moves, what you pay during the build, and how the loan becomes a long-term mortgage.
The loan amount is limited by the program's maximum loan-to-value against that finished value and by the total cost of land plus construction. On FHA, for example, the lender uses the lesser of the appraised value or the documented acquisition cost (II.A.8.j.iv).
How you hold the lot changes the cash picture. If you already own it free and clear, many programs let its value or cost count toward your investment, which can reduce the cash you need at closing. If there's still a loan on the lot, the construction loan usually pays it off at the first closing, and the remaining equity counts. If you're buying the lot at the same time, the lot purchase is part of the total cost being financed.
The program decides whether value or original cost is used. FHA is a good example: land you've owned more than six months at case number assignment, or received as an acceptable gift, counts at its appraised value. Land owned six months or less, or bought at closing, counts at the lesser of its cost or appraised value (HUD 4000.1 II.A.8.j.iv).
The contract between you and the builder sets the price, the schedule, the specifications, and who pays for overruns. A fixed-price contract puts more of the cost risk on the builder. A cost-plus contract passes actual costs through to you plus a fee. Cost overruns belong to whoever the contract names.
The lender reads that contract closely, because an overrun nobody can pay for is how a project stalls with a half-built house and a loan that can't fund the rest. Many lenders want a contingency in the budget and want to see reserves beyond it. Change orders that add cost generally have to be approved by the lender and funded before the work goes on.
The loan funds in draws. A typical schedule ties draws to stages like foundation, framing, dry-in, mechanicals, drywall and completion, but the schedule is set by the lender and the contract. Before each draw, an inspector visits the site and confirms the work is done. The lender may also require lien waivers from the builder and major subcontractors and a title update showing no new liens.
The agencies build this in. On an FHA construction-to-permanent loan, the money left after the land is paid goes into an escrow account, and the lender needs your written authorization before each draw goes to the builder (HUD 4000.1 II.A.8.j.ix). USDA has the same idea: draws released only after the work is complete, with your written approval (7 CFR 3555.105(a)).
During the build, the loan is often interest-only on the amount drawn. Early on, when only the lot and foundation are funded, the interest is small. It grows as more money goes out. Some construction loans let interest build into a reserve in the budget instead of being paid monthly. The loan agreement says which. Plan for that payment alongside your current rent or mortgage, since most people are paying for their current home during the build.
One-time close offers more certainty about the permanent loan and one set of closing costs. Two-time close offers more flexibility in choosing the permanent loan, at the cost of requalifying at the end.
On a one-time close, the permanent rate is its own lock. Some loans lock it at the start, and some float until conversion. On FHA, if the rate floats during construction, there has to be a written agreement that sets the range, the lock point and a maximum permanent rate, and you're qualified at that maximum (HUD 4000.1 II.A.8.j.vii). On a two-time close, the construction loan has its own pricing, and the permanent loan is locked when that application is active, near completion. See how a rate lock works.
A construction-only loan can be exempt from some RESPA rules as temporary financing, but that exemption doesn't apply when the loan converts to permanent financing with the same lender (12 CFR 1024.5(b)(3)). Under Regulation Z, a lender can disclose the construction and permanent phases together or separately (12 CFR 1026.17(c)(6)(ii)). Either way, you get a Loan Estimate and a Closing Disclosure.
A house under construction needs builder's risk insurance, which covers the structure against losses like fire, wind, and theft of materials while it's being built. The contract says whether the builder or you carry it, and the lender is named on the policy. When the house is finished, a regular homeowners policy replaces it. If the lot is in a flood zone, flood insurance requirements apply too.
When a builder builds a house on its own lot with its own financing and sells it after completion, or near completion, you use a regular purchase mortgage. The builder carried the construction risk. That purchase may come with a builder's contract, an incentive package, and new-construction appraisal and tax considerations, but it closes like any purchase. See buying new construction.
This example is made up to show how the pieces fit.
A couple owns a lot near Aledo and hires a builder. At first they ask for "a mortgage like a normal resale," but the file is a construction file until the house exists. They choose a one-time close. Before closing, the builder provides plans, specifications and a line-item budget, both spouses sign the construction contract, and it's recorded. The lot's appraised value counts toward their investment because they've owned it for years. Draws go out after each inspection, with lien waivers collected along the way. A change order for a larger garage gets lender approval and is paid in cash before the work starts. After the final inspection, the loan converts and regular payments begin.
Planning to build? Send me the lot details, the builder's bid and the plans before you sign anything, and I'll show you how a construction loan would be structured and what cash you'd need. Schedule a call, or when you're ready, start an application.
Links checked Oct 21, 2026.
About the author: McKade Lively, NMLS 2704474, American Pacific Mortgage Corporation dba True North Home Loans, NMLS 1850.
Equal Housing Opportunity.
Last reviewed: Oct 2026