When Do You Pay Closing Costs on a Construction Loan?

Building a new home involves a unique financing process compared to purchasing an existing property. Construction loans are specifically designed to fund the building phase, providing staged disbursements as construction progresses. Like any loan, they come with various closing costs, but the timing and structure of these costs can differ significantly from a traditional mortgage.

Typical Closing Costs for Construction Loans

Closing costs are fees associated with processing and securing a loan, covering services from initial application through various stages of the building process. The total closing costs for new construction can typically range from 2% to 6% of the home’s purchase price. This percentage can vary based on factors such as the loan type, the location of the property, and the specific lender.

One common fee is the loan origination fee, which lenders charge for processing and approving the loan application. These fees often range from 0.5% to 3% of the total loan amount. Appraisal fees are also standard, though construction loans may require multiple appraisals: an initial one for the lot and a final inspection of the completed home.

Title insurance is another typical cost, protecting the lender from issues like ownership disputes or outstanding liens, and may involve an initial policy with potential updates throughout the construction. Inspection fees are common for construction loans, as lenders often require periodic site inspections to verify progress before disbursing funds, known as draws. These inspections typically cost between $75 and $150 per visit for residential projects.

Legal and recording fees are also incurred to officially document the property’s deed and mortgage. Survey fees may be necessary, particularly if purchasing the land for the new construction. Underwriting fees cover the cost of assessing the borrower’s creditworthiness and the project’s feasibility.

An interest reserve is a portion of the loan proceeds set aside to cover interest payments during the construction period, when the property is not yet generating income. It helps manage cash flow by allowing borrowers to defer interest payments until the home is complete. This reserve is calculated based on the loan amount, interest rate, and expected duration of construction, and is drawn upon monthly to cover interest expenses.

When Closing Costs Are Paid

The timing of closing cost payments for construction loans differs from traditional mortgages, where most costs are paid at a single closing event. For construction loans, costs can be spread across various stages of the home-building process.

At the initial loan closing, before construction begins, several costs are typically due upfront. These often include loan origination fees, initial appraisal fees for the land, title insurance premiums, and legal and recording fees for the loan documents. These payments secure initial financing and establish the project’s legal framework.

During the construction phase, additional costs may arise or be paid periodically. Draw inspection fees are a recurring expense, paid each time a portion of the loan is disbursed to the builder, typically as construction milestones are met. These fees ensure the lender that work is progressing as planned. Property taxes and homeowners insurance premiums may also be due upfront at closing, with lenders often requiring prepayment for several months to a year. Some lenders might also require an initial deposit into an escrow account to cover future tax and insurance payments.

If the construction loan is structured to convert into a permanent mortgage upon completion, additional closing costs may be incurred at that final closing. These can include new appraisal fees for the completed home, updated title insurance to reflect the new permanent loan, and other fees for securing the permanent financing, such as underwriting or processing fees.

Impact of Construction Loan Structures on Payments

The specific structure of a construction loan significantly influences the number of times closing costs are incurred and their overall impact. The two primary structures, construction-to-permanent and construction-only loans, each have distinct implications for payment timing and potential cost duplication.

A construction-to-permanent loan, also known as a single-close or one-time close loan, streamlines the financing process by combining the construction phase and the permanent mortgage into a single loan. With this structure, borrowers typically incur only one set of closing costs at the initial loan closing, before construction begins. While there might be a modification fee or similar administrative charge at the time of conversion, it generally does not equate to a complete second set of closing expenses. This single-close option can lead to cost savings and a simpler process.

Conversely, a construction-only loan is a short-term loan specifically for the building phase. Once construction is complete, this loan must be paid off or refinanced into a separate, permanent mortgage. This structure typically involves two distinct closing events, resulting in two sets of closing costs. This often means duplicating certain fees, such as appraisal fees and title insurance, as these services may be required for both loans. The two-close structure can therefore result in higher overall closing costs compared to a single-close option.