26th Jun 2026
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A construction loan is a short-term loan that funds the cost of building a new home from the ground up. Unlike a traditional mortgage, which finances a completed property in a single lump sum, a construction loan releases funds in stages as the build progresses. Once construction is finished, the loan is either paid off or converted into a permanent mortgage.
If you're planning to build a custom home in Michigan or anywhere else Sistar Mortgage is licensed, understanding how construction loans work is the first step.
What Does a Construction Loan Cover?
You can use a construction loan to pay for most costs directly associated with building the home, including:
- Land purchase or lot acquisition
- Contractor labor and general contractor fees
- Building materials, from foundation to final fixtures
- Permits and municipal fees
- Site preparation and landscaping
One cost construction loans don't cover is architectural or interior design fees. If you're working with an architect or designer, those expenses come out of pocket and should be budgeted separately before you apply.
How Do Construction Loans Work?
Construction loans work differently from standard mortgages in a few important ways. The term is short, typically 6 to 18 months, and the funds are disbursed in stages rather than all at once. Those stages are called draws, and each one is tied to a verified construction milestone.
Before applying, you or your general contractor will need to provide the lender with a construction timeline, a detailed project plan, and a realistic budget. Based on that, the lender approves a maximum loan amount. As the build progresses and each milestone is completed, an inspector confirms the work and the lender releases the corresponding draw, usually paid directly to the contractor.
During the construction phase, you make interest-only payments on the funds drawn to date, not on the full loan amount. So if you've drawn $100,000 of a $400,000 loan, you're paying interest only on $100,000. Those payments grow as more draws are released, but they stay manageable compared to a full principal-and-interest mortgage payment.
When construction is complete, one of two things happens depending on the loan type you chose: you either pay off the construction loan with a separate mortgage, or the loan automatically converts to a permanent mortgage, no second closing required.
Construction Loans vs. Traditional Mortgages
Beyond the short-term and staged disbursements, there are several meaningful differences between a construction loan and a traditional mortgage.
| Factors | Construction-only | Traditional mortgage | Construction-to-perm |
| Loan term | 6–18 months | 15–30 years | Build phase + 15–30 yrs |
| Payments during build | Interest-only on draws | N/A — home already exists | Interest-only on draws |
| Interest rate | ~1% above mortgage rates | Standard market rate | Locks at closing |
| Number of closings | Two (build + permanent) | One | One |
| Down payment | Typically 20–25% | As low as 3–5% | Typically 20–25% |
Construction loan rates are typically about 1 percentage point higher than conventional 30-year mortgage rates. That's because the lender doesn't have a completed home to use as collateral. If something goes wrong during the build, cost overruns, contractor issues, or permitting delays, the lender's exposure is higher than it would be on a finished property. That added risk is priced into the rate.For construction-to-permanent loans, the rate locks at the original closing. That means your permanent mortgage rate is set before construction begins, which can be an advantage in a rising-rate environment.
Types of Construction Loans
There are three main types of construction loans, and the right one depends on your situation, your builder, and how many closings you want to manage.
1. Construction-to-Permanent Loan
A construction-to-permanent loan, also called a one-time-close construction loan, combines the construction financing and the permanent mortgage into a single loan. You apply once, close once, and pay one set of closing costs. During the build, you make interest-only payments. When the certificate of occupancy is issued, the loan automatically converts to a standard amortizing mortgage with principal-and-interest payments.
This is Sistar Mortgage's primary construction loan product and the structure we recommend for most borrowers. The rate you lock at the original closing is the rate that carries through to the permanent mortgage, which removes the uncertainty of shopping for permanent financing after the build is done.
Construction-to-permanent loans are available in conventional, FHA, and VA versions. FHA construction loans allow down payments as low as 3.5% and minimum credit scores of 620. VA-eligible veterans may qualify for a VA construction-to-permanent loan with no down payment required.
2. Construction-only Loan
A construction-only loan covers the build phase and nothing beyond it. When construction is complete, you pay the loan off in full, typically by taking out a separate permanent mortgage. Because this involves two separate loan applications and two sets of closing costs, it's sometimes called a two-time-close construction loan.
The main reason to choose this structure is rate flexibility. You apply for permanent financing after the build is finished, which means you can shop the rate environment at that point. The trade-off is the added cost of two closings and the risk that your financial situation or credit profile shifts during the construction period, potentially affecting what you qualify for later.
3. Owner-Builder Construction Loan
An owner-builder loan is for borrowers who want to act as their own general contractor rather than hiring one. Most lenders require the borrower to hold a valid contractor's license or provide documented construction experience before approving this structure. If you qualify, it can reduce costs meaningfully. If you're new to construction, the risks of managing a build without a licensed GC typically outweigh the savings.
How Construction Loan Draws Work
The draw schedule is the mechanism that controls how and when funds are released throughout the build. Rather than receiving the full loan amount upfront, you access money in stages as each construction milestone is verified by an independent inspector.
Typically, a build involves four to six draws over the life of the construction period.
| Draw | Milestone | % of loan typically released |
| 1 | Site prep and foundation | 10–15% |
| 2 | Framing complete | 15–20% |
| 3 | Mechanical rough-in (plumbing, electrical, HVAC) | 15–20% |
| 4 | Drywall, insulation, exterior finishes | 15–20% |
| 5 | Interior finishes, fixtures, and final landscaping | 15–20% |
| Final | Certificate of occupancy issued | Remaining balance |
Each draw is funded only after an inspection confirms the milestone is complete and the work meets the required standard. The lender pays the draw directly to the contractor in most cases, not to you. You begin paying interest on each draw amount as soon as it's released.
The draw system protects both parties. You pay interest only on funds actively in use, not on the full loan commitment. The lender releases funds only against completed, verified work. It's a structure that keeps the project accountable throughout the build and reduces the risk of contractors being paid before deliverables are delivered.
Construction Loan Requirements
Qualifying for a construction loan is more involved than qualifying for a standard mortgage. Here's what lenders typically require:
Credit Score
Most lenders require a minimum credit score of 680 for a conventional construction loan, though some accept 620, particularly for FHA-backed programs. At Sistar Mortgage, we work with borrowers across this range and evaluate the full credit profile, not just the score, to identify the most appropriate loan structure.
Down Payment
Standard construction loans require a down payment of 20 to 25 percent, considerably more than the 3 to 5 percent available on many conventional purchase mortgages. The higher requirement reflects the lender's exposure to a property that doesn't yet exist as collateral.
FHA construction loans reduce the minimum to 3.5 percent for qualifying borrowers. VA-eligible veterans may be able to finance a custom build with no down payment at all through a VA construction-to-permanent loan.
Borrowers who already own land outright are in a stronger position than they often realise. That land equity typically counts toward the down payment requirement, which can significantly reduce the cash you need to bring to closing.
Debt-to-income Ratio
Most construction loan programs require a debt-to-income ratio of 45 percent or below. Importantly, lenders calculate DTI using your projected permanent mortgage payment, not just your current monthly debts. It's worth running that number before you apply, so there are no surprises in underwriting.
Builder Approval
Lenders don't just underwrite the borrower; they also underwrite the builder. Your general contractor must be licensed, insured, and approved by the lender before the first draw can be advanced. You'll need to submit documentation that includes the contractor's license, insurance certificates, a signed construction contract, a detailed project timeline, and professional references.
If you haven't selected a builder yet, our team can walk you through what credentials to look for and help connect you with qualified contractors in the Michigan market.
Construction Plans and Budget
A detailed set of construction plans and a complete project budget are required before the lender can issue an approval. The more thorough your documentation, the smoother the underwriting process. Your lender will also order an as-completed appraisal, an estimate of the finished home's market value based on your plans and comparable sales in the area. That appraised value sets the ceiling on how much you can borrow.
Construction Loan Rates and Costs
Construction loan rates are typically 1 to 2 percentage points higher than conventional 30-year mortgage rates. Most construction loans carry variable rates that fluctuate with the prime rate during the build phase, though construction-to-permanent loans often lock the rate at closing, removing that variability.
Beyond the interest rate, here's what to budget for:
- Origination fees: Typically 0.5 to 1 percent of the loan amount
- Draw inspection fees: Usually $100 to $200 per inspection visit, budget $500 to $1,000 for a standard five-draw build
- Closing costs: Paid once with a construction-to-permanent loan; paid twice with a construction-only loan
- Contingency reserve: Most lenders require 5 to 10 percent of the total budget held as a contingency for unexpected cost overruns
How to Get a Construction Loan
The steps for getting a construction loan are similar to a traditional mortgage in some ways and more involved in others. Here's what the process generally looks like:
1. Find a Licensed, Lender-Approved Builder
Your contractor must be licensed, insured, and approved by your lender before any funds can be disbursed. Start with builder research early; lender approval of the contractor is part of underwriting, not a formality at the end.
2. Connect With a Construction Loan Lender
Not all mortgage lenders offer construction loans. Look for a lender with direct experience in construction loans, such as Sistar Mortgage, and compare programs, rates, and down payment requirements before committing.
3. Get pre-Qualified
Pre-qualification tells you how much you're likely to be able to borrow based on your financial profile. It also helps you set a realistic budget with your builder before committing to a project scope you can't finance.
4. Prepare Your Documentation
Construction loan applications require everything a standard mortgage does: pay stubs, W-2s, tax returns, bank statements, plus construction-specific documentation: signed builder contract, detailed project plans and budget, permitting timeline, and builder credentials.
5. Order The Appraisal
Your lender will commission an as-completed appraisal based on your construction plans and comparable sales. This value determines your maximum loan amount.
6. Close and Break Ground
For a construction-to-permanent loan, you close once, and construction begins. For a construction-only loan, you close on the construction portion now, with a second closing for permanent financing after the build.
7. Manage Draws Through to Certificate of Occupancy
As construction progresses, your builder requests drawings, inspections are completed, and funds are released. You pay interest only on disbursed funds throughout this phase.
8. Convert to Permanent Financing or Pay off the Loan
When the certificate of occupancy is issued, a construction-to-permanent loan converts automatically. A construction-only loan is paid off with a new mortgage you apply for separately.
Is a Construction Loan Right For You?
If you're building a custom home from the ground up, a construction loan is the standard financing vehicle for that project. The key decision is which structure, construction-to-permanent or construction-only, fits your situation, and that depends on your credit profile, down payment position, how much flexibility you want at the end, and whether you want to go through one closing or two.
For most borrowers, the construction-to-permanent loan is the simpler and more cost-effective path. One closing, one rate, one process. But the right answer depends on your specific numbers, which is why a conversation with a construction loan specialist before you commit to a structure is worth the time.
If you're also thinking through the longer-term budget, what your mortgage payment will be once construction is complete, what the total cost of ownership looks like over the first five years, our guide on the total cost of homeownership in 2026 covers those numbers in detail.
Get Pre-Qualified for a Construction Loan
Sistar Mortgage's construction loan team works with custom home buyers, landowners, and first-time builders. Tell us about your project, and we'll identify the right loan type and give you real numbers, not estimates.
< Get Pre-Qualified> <Speak With a Loan Specialist>
Frequently Asked Questions
What credit score do I need for a construction loan?
Most lenders require a minimum credit score of 680 for a conventional construction loan. FHA construction loans allow scores as low as 620 with a 3.5% down payment. Sistar Mortgage evaluates the full credit profile, not just the score, to identify the right loan structure for your situation.
How much down payment is required for a construction loan?
Standard construction loans require 20 to 25 percent down. FHA construction loans reduce this to 3.5 percent for qualifying borrowers. VA-eligible veterans may qualify for zero-down construction-to-permanent financing. If you own land outright, that equity often counts toward the down payment and can reduce how much cash you need at closing.
What if my construction project takes longer than expected?
Most construction loans can be extended if a project runs over the initial timeline, though the lender will typically review the cause of the delay and may charge an extension fee. In Michigan, where construction seasons are compressed by weather, delays are common, and most experienced construction lenders plan for them. Sistar offers extension options and will work with you and your builder when timelines shift.
How does a construction loan work when you already own the land?
If you own your land outright, that equity typically counts toward your down payment requirement, which can reduce the cash you need to bring to closing. The land's value is included in the total project cost, and the lender's loan-to-value calculation is based on the as-completed appraised value of the finished home, not just the land.
Can I use an FHA or VA loan for a new construction home?
Yes. FHA offers a construction-to-permanent program with a 3.5% minimum down payment and a 620 minimum credit score. VA-eligible borrowers may access a VA construction-to-permanent loan with no down payment required. Both programs are available through Sistar Mortgage.
Is it harder to qualify for a construction loan than a regular mortgage?
Generally, yes. Construction loans carry more lender risk than standard mortgages because there's no completed home to use as collateral. As a result, lenders typically require higher credit scores, larger down payments, and more documentation, including a builder contract, construction plans, and a project budget, than they would for a standard purchase mortgage.
