How a construction loan works
A construction loan isn't paid out all at once. The lender releases money in draws as the work is done, and during the build you usually pay only interest, on the amount drawn so far. The CFPB's guide describes the construction phase as having interest-only payments, with interest payable only on the amount advanced for the time it's outstanding.
With a construction-to-permanent loan, the construction loan then becomes (converts to) a regular mortgage. Fannie Mae describes two versions: a single closing, where the construction loan and the mortgage close together with one set of documents, and two closings, where an existing construction loan is rolled into a new mortgage.
How it's calculated
Construction interest = sum of the monthly payments
Permanent payment = loan × i ÷ (1 − (1 + i)−n)
By default the loan is drawn in equal amounts each month, and each draw is charged a full month of interest from the month it's made. Open "Draw schedule" to type your builder's actual draws; any months left blank share the rest equally.
The CFPB's disclosure rules use a simpler estimate: assume half the loan is outstanding for the whole build. That's shown too, so you can compare it with the Loan Estimate you get.
Worked example
A $300,000 loan at 8% over 12 months is drawn at $25,000 a month. Month 1's payment is 25,000 × 0.08 ÷ 12 = $166.67. By month 12 all $300,000 is out and the payment is $2,000. The payments add up to $13,000 of construction interest (the half-the-loan estimate gives $12,000). The loan then converts to a 30-year mortgage at 6.5%: $1,896.20 a month in principal and interest.
| Month | Drawn so far | Interest-only payment |
|---|---|---|
| 1 | $25,000 | $166.67 |
| 3 | $75,000 | $500.00 |
| 6 | $150,000 | $1,000.00 |
| 9 | $225,000 | $1,500.00 |
| 12 | $300,000 | $2,000.00 |
Limitations
- Lenders may charge interest daily from the exact draw date, so a draw mid-month costs less than a full month.
- Some loans set aside an interest reserve, or charge inspection and draw fees. Those aren't included.
- The rates here are editable examples, not today's rates. Your permanent rate may be locked at closing or set at conversion.
- The permanent payment is principal and interest only. Add taxes and insurance in the mortgage calculator.