A construction-to-permanent loan pays your builder in stages (draws) while the home goes up. During the build you pay interest only on what has been drawn so far, so the payment starts small and climbs. When the home is finished, the loan converts into a normal mortgage with principal and interest. Below is how each stage works, with a 12-month example you can rerun in the construction loan calculator.
The three stages of a construction loan
- Closing: the lender approves you, the builder, the plans and the budget, then appraises the home as it will be when finished. You pay your down payment and closing costs. If the loan buys the land, that part is usually paid out at closing.
- The build (draw period): the builder requests money as work is completed — foundation, framing, roof, mechanicals, finishes. The lender usually sends an inspector before releasing each draw. You pay interest on the drawn balance only.
- Conversion: after the final inspection and certificate of occupancy, the loan becomes a regular amortizing mortgage, typically 15 or 30 years. With a single-close loan there is no second application or closing.
Worked example: a $500,000 project over 12 months
Take a project with $80,000 for the lot, $400,000 for the build and $20,000 of soft costs (permits, plans, fees) — $500,000 in total. The lender wants 20% down on the whole project, so you bring $100,000 and borrow $400,000, which is 80% loan-to-cost. The example construction rate is 8.5% and the permanent rate after conversion is 6.75% for 30 years. Both rates are illustrative; use your own quotes.
To keep the arithmetic clear, assume the builder draws the loan in equal monthly amounts of $33,333. Each month's interest is the drawn balance × 8.5% ÷ 12:
- Month 1: drawn balance $33,333, interest payment about $236
- Month 3: drawn balance $100,000, interest payment about $708
- Month 6: drawn balance $200,000, interest payment about $1,417
- Month 9: drawn balance $300,000, interest payment about $2,125
- Month 12: drawn balance $400,000, interest payment about $2,833
Total interest over the build comes to about $18,417, an average of $1,535 a month. That is much less than paying interest on the full $400,000 for 12 months ($34,000), because for most of the build only part of the loan is out.
A useful shortcut for equal draws: total build interest ≈ loan × monthly rate × (months + 1) ÷ 2. Here that is $400,000 × 0.7083% × 6.5 ≈ $18,417.
The payment after conversion
When the house is finished the $400,000 balance converts to a 30-year mortgage at 6.75%. Principal and interest become about $2,594 a month, before property tax, insurance and any mortgage insurance. Compare that with the last interest-only payment of the build, about $2,833: here the payment actually falls by about $239, because the construction rate is higher than the permanent rate. It is the start of principal repayment, plus property tax and insurance on a finished home, that makes the full monthly cost after move-in higher than most of the build months, so budget for it before you sign.
The permanent rate matters more than the construction rate over the life of the loan: at 7.25% instead of 6.75%, the payment would be about $2,729, or $1,612 more a year. Ask whether your single-close loan locks the permanent rate at closing, lets you float it, or offers a one-time "modification" if rates fall during the build.
What changes the cost of the build
- Time. Stretch the same build to 15 months and the interest rises to about $22,667, $4,250 more, because the balance is outstanding longer. Weather, inspections and material delays all cost interest.
- Draw timing. Real draws are lumpy, not equal. If a large share is drawn early (for example the land and foundation), more of the loan accrues interest for longer than the equal-draw estimate suggests.
- Land you already own. If you own the lot outright, its value can often count toward the down payment. In this example, owning the $80,000 lot would cut the cash needed at closing to $20,000, while the loan stays $400,000.
- Cost overruns. The lender funds the approved budget, not the final bill. Overruns are usually paid in cash, so keep a contingency of 5% to 10% of the build cost outside the loan.
Single-close vs two-close construction loans
A single-close (construction-to-permanent) loan has one approval and one set of closing costs, and you know the permanent terms before the first board is cut. A two-close loan is a short construction loan that you pay off with a new mortgage when the home is done. Two-close can win if rates fall during the build or your finances improve, but you pay closing costs twice and must qualify again at the end, when your cash may already be spent on the house. If you are building while you still own your current home, a bridge loan can cover the gap until it sells.
Checklist before you sign
- The construction period, and what an extension costs if the build runs over.
- How and when draws are inspected and paid, and who signs off each one.
- Whether the permanent rate is locked at closing and for how long.
- Who holds the contingency, and what happens to unused funds at the end.
- The full monthly payment after conversion, including taxes and insurance — the mortgage calculator adds them to the principal and interest above, and the closing cost calculator estimates the cash you need at closing.
Run your own lot price, budget, rate and timeline in the construction loan calculator: it shows the interest on every draw, the total build interest and the mortgage payment after conversion.