Construction Loans and Land Loans: A Complete Guide

Buying land and building a home from scratch is a completely different financing process than buying an existing house. There is no finished home to appraise, no single closing, and often two loans instead of one. Here is how construction and land financing actually works.

A land loan finances the purchase of a vacant lot, with no immediate plan to build. A construction loan finances the actual building process once you are ready to start. Some borrowers only need one of these. Others need both, especially if they are buying raw land now and building later.

Land loans generally require a larger down payment than a home loan. Raw land is considered higher risk collateral without a structure on it. If you already own your land outright, that ownership can typically count toward your down payment when you move into construction financing.

Unlike a regular mortgage, a construction loan does not hand you the full amount up front. According to the Consumer Financial Protection Bureau’s explanation of construction loans, funds are typically released through a series of advances as construction progresses.

During construction, you typically make interest-only payments on the amount that has been drawn so far, not on the full loan amount. This keeps costs lower during the building phase, when you may also be paying rent or a mortgage on your current home.

There are two common structures for how this connects to your long-term mortgage.

Construction-to-permanent loans, sometimes called one-time close loans, combine the construction financing and the long-term mortgage into a single loan. There is just one closing. Once construction is complete, the loan automatically converts into a standard mortgage. There is no second approval process or second set of closing costs.

Stand-alone construction loans, sometimes called two-time close loans, only cover the building phase. Once construction finishes, you apply separately for a permanent mortgage to pay off the construction loan. This means two closings and two sets of closing costs, but it can offer more flexibility if your plans might change during the build.

Construction loans generally carry stricter requirements than a loan for an existing home. There is no completed structure to serve as collateral during the build.

Factor	Typical Guideline
Minimum credit score	680, with many lenders preferring 720 or higher
Down payment	Typically 20% to 25% of total project cost, though some lenders allow 10% to 15% with strong credit and land equity
Maximum DTI	Generally around 45%
Appraisal	Based on the home’s estimated value once complete, not current land value alone
Builder requirements	Lender approval of your builder, detailed plans, and a construction budget
Loan term during construction	Typically 6 to 18 months, before converting or being refinanced

These are general market guidelines, not a promise from Wonder Rates. Requirements vary significantly by lender, project size, and whether you already own the land.

Not every construction loan requires 20% or more down. FHA offers a One-Time Close construction-to-permanent loan with a minimum down payment of 3.5% and credit scores as low as 580 accepted by some lenders, following standard FHA guidelines. VA construction loans can also offer very low or no down payment for eligible veterans and service members. Fewer lenders offer VA construction financing compared to FHA.

These lower down payment programs generally apply to building a primary residence, not an investment property. They typically require working with an approved builder rather than acting as your own general contractor.

Some borrowers want to act as their own general contractor rather than hiring one, often called an owner-builder construction loan. These are harder to find, since fewer lenders offer them. You typically need to demonstrate relevant construction experience and submit detailed plans. Lenders often require a larger down payment than a builder-managed project would need.

A home under construction needs different coverage than a finished, occupied home. Builder’s risk insurance is generally required during the construction period. It covers the structure itself, materials on site, and often equipment, against risks like fire, theft, or storm damage while the home is unfinished. Once construction is complete and the home is occupied, this policy is typically replaced by a standard homeowners insurance policy. Your lender will usually confirm this coverage is in place before releasing draws and again before the loan converts to a permanent mortgage.

How much down payment do I need for a construction loan?
Typically 20% to 25% of the total project cost, though some lenders accept 10% to 15% with strong credit and reserves. If you already own your land free and clear, that equity can often count toward your down payment.

What is the difference between a construction-to-permanent loan and a stand-alone construction loan?
A construction-to-permanent loan combines both phases into one loan with a single closing. A stand-alone construction loan only covers the building phase. It requires a separate application and closing for the permanent mortgage afterward.

Can I get a construction loan with a low down payment?
Yes, in some cases. FHA’s One-Time Close program allows a minimum down payment of 3.5% for primary residences, and VA construction loans may offer very low down payment options for eligible veterans.

How are funds actually paid out during construction?
Funds are released in stages called draws, tied to specific completed milestones such as the foundation, framing, and final finishes, rather than as one lump sum at closing.

Can I use my own land as part of my down payment?
Generally yes, if you own the land outright. Its value can typically be credited toward your required down payment when you apply for construction financing.

This article is for general educational purposes and is not a commitment to lend. Construction loan requirements, terms, and rates vary significantly by lender and can change over time.

If you are considering building instead of buying an existing home, Wonder Rates can walk through construction and land loan options based on your specific project.

[Talk to a loan officer about construction financing →]

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Wonder Rates, Inc. | NMLS# 1518655
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This article is for educational purposes only and is not a commitment to lend. Loan approval is subject to creditworthiness, income verification, property eligibility, and current underwriting guidelines. Loan programs, interest rates, and lender fees may change without notice. Always review your official Loan Estimate before making a financing decision.