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Construction projects can and do end up taking longer than expected from time to time. This is often due to issues with permits, inspections, material delays, etc.
If we don't finish on time, we will pay your lost rent or carrying costs for every day we go over our schedule. This is our QB schedule guarantee. On Time Or It's On Our Dime!
How to Finance Your Project with Construction Loans?
How to Finance Your Project with Construction Loans?
A construction loan is a short-term builder loan. It helps you construct a property from scratch. Or you can use it for major renovation work. Once the construction is over, you will switch to a long-term mortgage. That means a construction loan acts as a bridge. You will refinance into a different mortgage once the project is finalized.
On this page, we’ll discuss:
How do construction loans work?
How do you choose the best type of loan for your project?
Interest rates on construction loans
Timeline
Approval process
How Does a Construction Loan Work?
The amount issued for a construction loan is based on the after-repair value of your property. The lenders will request an appraisal to determine your home’s market value once it’s renovated or constructed. You can use the construction loan to finance new construction or to renovate a fixer-upper. With construction loans, you have the flexibility to construct as you like.
Most banks would give you 12–18 months to complete the construction work after the loan is approved. The loan amount is delivered gradually into installments as the project progresses.
Construction Loan Interest Rates
Construction loans have a short repayment period. The loan is paid once you refinance the property. That’s why these loans have a high interest rate compared to regular mortgage products. You can expect an increase of 1% above the traditional borrowing rates. Construction loans can have variable interest rates. Multiple inspections and paperwork are required for a successful loan draw.
Construction Loan Vs a Mortgage
Construction loans are divided into phases. You first opt for lender approval, where you've got to prove your financial capability and the market value of your property. After that, you work with a builder to finalize the construction plan (permits, architectural drawings, and design). Then the actual construction begins, and after necessary inspections, your project comes to an end. The final step is to refinance the construction loan into a long-term mortgage.
Because of all these steps, it’s actually better to opt for FHA 203k, or homestyle renovation. But we’ll discuss why some people would choose a construction loan in Chicago.
How to Qualify for a Construction Loan?
Minimum credit score of 680
Debt-to-income ratio of 43% or less
Minimum down payment of 20% (Some lenders might require 30%)
Contract with a licensed builder who will carry out the construction
A home appraisal report
A construction plan
The qualification process is simple and similar to other housing loans. The lender will first determine your financial eligibility. You will need to provide your credit score, details of assets, and financial obligations. You also need to show whether you’re constructing your primary residence or an investment property.
The lender must also approve the builder. You will work with a lender-approved builder for the construction of your project. Lenders would like to see the builder’s credit, project history, licenses, and insurance. Most lenders will only approve a contractor who has experience tackling similar renovation projects. In that phase, it’s important to provide detailed estimates or construction bids. Before your loan is approved, lenders will evaluate the contractor's bid down to the smallest detail, including the timeline, cost, and material choice.
You will also need to submit your construction plan. Lenders want to ensure that quality construction will be completed and the proposed timeframe aligns with loan terms.
Need a 203k Certified Contractor?
Check out203kcontractors.comwhere you can find vetted 203k contractors near you.
How to Get Approved for a Construction Loan?
Choose a licensed builder who will construct/renovate your home. Your general contractor must have experience and a license to renovate your property. Only then will the lender approve the builder. Contractor approval will be the first step. After that, you need to provide ARV estimates and detailed construction plans. Here is a preview of the steps involved:
Choose a licensed builder.
Find a construction loan lender.
Gather all your documents.
Get pre-approved for the loan.
Get homeowner insurance for the construction project.
Complete the construction and necessary inspections.
Refinance the house.
Which Documents Are Required for Construction Loan Approval?
Documents can vary, but this list will give you an idea of the required paperwork.
Income proof and bank statements
Credit report
Detailed building plan
Construction contract
Contractor contact information
Cost estimate for the entire project
Project timeline and expected schedule
How to Receive Money for Construction Work?
You can borrow up to 80% of your home’s market value after construction. You will not receive all the money at once. Instead, the funds will be disbursed in multiple installments. You will pay interest only on the drawn amount.
With each draw, a certified inspector will visit your house to ensure work was completed according to the standard. These inspections requiring back-and-forth approval cause delays, but that’s how a construction loan works. You will have to wait before the bank completes the inspections and releases funds. Sometimes a bank may withhold 10% funds for each draw request until the specified work is complete. Your contractor might have to pay out of pocket for certain expenses. That’s why it’s challenging to find competitive contractors who will work on projects with construction loan financing.
QB Tip: Construction loans do not cover design costs or interior design costs.
Alternatives to Construction Loan
Construction loans are good for investors who will sell the house shortly after remodeling. If you can sell the house quickly within a few months, then opting for a construction loan makes sense. Your interest rate would be better than private money loans.
Construction loans are suitable when you’re constructing from scratch or the renovation cost exceeds $25,000. These loans come with high loan origination fees and interest rates. Since it’s a short-term loan, it’s best to choose a HELOC if your total cost would be less than $25,000. Other mortgages such as FHA 203k and Fannie Mae Homestyle are also good alternatives that don’t require refinancing.
Frequently Asked Questions
How much can I borrow with a construction loan?
Most banks will lend you 80% of the construction cost or the ARV. If your construction cost is $300k but the ARV is $550k, then you can borrow 80% of the $550k.
Construction loans are considered riskier than mortgage payments. The down payment depends on the lender's requirements, but most will require a 20% down payment. The value of land can be rolled into the down payment depending on the land’s value.
Why are interest rates higher than traditional mortgages?
Interest rates are high according to the conceived risk. Loans for construction projects are short-term (12-24 months), and it’s not possible to amortize the risk over decades. Half-built homes are riskier collateral than move-in-ready properties. Current rates typically run 1-1.5% above conventional mortgages, but this premium disappears once you refinance to a permanent mortgage.
Can I Hire My Contractor?
You can propose any licensed builder, but lenders require:
Proof of experience (minimum 2-5 similar projects)
Financial stability (bonding/insurance coverage)
Detailed bids matching the construction timeline
Many lenders maintain approved contractor lists—using one can streamline approval but may limit negotiation flexibility.
What if construction goes over budget or timeline?
Construction loans have a contingency reserve to cover 10-15% cost overruns. Major delays can trigger loan extension fees, which need to be discussed with your lender upfront. Always build a 15-20% buffer into both your budget and timeline before applying.
