Do You Pay a Mortgage While a House Is Being Built?

Building a new home involves different financial obligations during construction compared to purchasing an existing property. Understanding these unique considerations is important for new construction projects.

Understanding Construction Financing

Financing a new home build involves a specialized product known as a construction loan, which differs from a traditional mortgage. Unlike a standard mortgage that provides a lump sum for an existing property, a construction loan disburses funds in stages. These staged disbursements, known as “draws,” occur as specific construction milestones are met and verified by inspections.

There are two primary structures for construction financing. The first is a construction-to-permanent loan, often called a single-close loan. This option combines the construction phase financing and the permanent mortgage into one loan agreement, requiring a single closing process. The terms for the permanent mortgage are often set at the outset, providing rate certainty.

The second structure is a construction-only loan, a two-close arrangement. Under this model, borrowers secure a temporary loan for the construction period. Once the home is complete, a separate, traditional mortgage must be obtained to pay off the initial construction loan, necessitating a second application, underwriting process, and closing.

Payments During Construction

During the construction phase, borrowers typically do not make principal payments on their construction loan. Instead, payments are generally interest-only, calculated on the amount of funds disbursed through draws. As construction progresses and more funds are drawn to cover expenses like framing, plumbing, or electrical work, the outstanding loan balance increases, leading to higher monthly interest payments.

The interest rate on a construction loan is often variable, tied to a benchmark rate like the prime rate, meaning payments can fluctuate. Principal payments on the loan generally begin only after the construction phase is fully completed and the loan transitions into its permanent mortgage phase.

Beyond the loan interest, homeowners are responsible for other financial obligations during construction. Property taxes must be paid, initially based on the value of the land alone and then increasing as the home’s value grows with each stage of construction. A builder’s risk insurance policy is typically required, protecting the property from damage or loss during the building process.

Converting to a Permanent Mortgage

Upon completion of construction, the financing arrangement transitions to a permanent mortgage. For those with a construction-to-permanent, single-close loan, this transition is generally seamless. The loan automatically converts from the interest-only construction phase to a traditional principal and interest repayment schedule. This conversion usually occurs after a final inspection confirms the home’s completion and often a re-appraisal to determine its final market value.

Conversely, borrowers who opted for a construction-only loan face a more involved process. Once the home is built, they must apply for a new, separate permanent mortgage. This requires a full underwriting process, including income and credit verification, a new appraisal of the completed home, and a second closing. The funds from this new permanent mortgage are then used to pay off the temporary construction loan.