When Do You Start Paying a Construction Loan?

A construction loan serves as a specialized financial instrument designed to fund the building of a new home or a significant renovation project. Unlike a traditional mortgage, which provides a lump sum for an already completed property, a construction loan disburses funds incrementally as construction progresses. The loan’s design accommodates the phased nature of construction, aligning fund availability with project milestones rather than releasing the entire amount upfront.

Payments During Construction

Payments on a construction loan typically commence shortly after the loan’s initial closing, often within the first month. During the construction phase, borrowers generally make interest-only payments. Each payment covers only accrued interest on disbursed funds, with no portion applied to the loan’s principal balance. Interest due is tied to the cumulative amount drawn.

As construction advances and more funds are requested and disbursed by the lender, the outstanding loan balance increases, leading to a corresponding increase in the monthly interest payment. For instance, if a borrower draws $100,000 initially, their interest payment is calculated on that amount. Upon drawing an additional $50,000 for the next phase, the interest payment then reflects the total $150,000 drawn. This incremental structure continues monthly. The interest rate, fixed or variable, impacts payment calculation.

Borrowers typically receive a draw schedule from their lender, outlining when funds will be disbursed based on completed construction stages. Each draw request is usually followed by a property inspection to verify the work completed before funds are released. This ensures interest payments reflect the principal utilized. The interest-only phase continues until the construction project is substantially complete or reaches a predetermined milestone, at which point the loan structure transitions.

Transition to Permanent Financing

Upon the substantial completion of the construction project, the payment structure of a construction loan undergoes a significant change, transitioning from interest-only payments to principal and interest (P&I) payments. This shift occurs through one of two common loan models: a “construction-to-permanent” loan or a “two-time close” process. The construction-to-permanent model, also known as a one-time close loan, involves a single loan origination that converts to a permanent mortgage once the home is built. Under this arrangement, the terms for the permanent financing are typically established at the outset, and the loan automatically re-amortizes into a traditional mortgage once construction is complete and a certificate of occupancy is issued.

Conversely, the “two-time close” model requires two separate loan applications and closings. A construction loan is obtained to fund the build, with interest-only payments made during this period. Once construction concludes, borrowers apply for a new, separate permanent mortgage to pay off the construction loan. This process often involves a new underwriting review, additional closing costs, and a new appraisal to determine the property’s final value. While it offers flexibility to shop for permanent mortgage rates after construction, it also entails a second set of fees and a more involved closing procedure.

Regardless of the model chosen, the transition marks the point where the borrower begins repaying both the principal amount borrowed and the accrued interest over the full loan term, typically 15 to 30 years. The entire outstanding balance of the construction loan, or the full amount of the permanent mortgage, becomes subject to these P&I payments. This final phase of repayment mirrors that of a standard home mortgage, with fixed or adjustable rates determining the monthly payment amount for the duration of the loan.

Factors Influencing Payment Schedules

Several elements influence the payment schedule and overall cost of a construction loan, beyond the basic interest-only structure. The draw schedule, which dictates the timing and amount of fund disbursements, directly impacts the interest payments during construction. If a project proceeds rapidly and requires larger, more frequent draws, the outstanding loan balance increases more quickly, leading to higher monthly interest payments sooner in the construction timeline. Conversely, slower draws or delays in reaching construction milestones keep early interest payments lower but extend the overall interest-only period.

Construction delays are another substantial factor affecting payment schedules and total costs. Unforeseen issues such as weather delays, material shortages, or contractor availability prolong the construction phase beyond the initial estimate. Each additional month of construction extends the period during which only interest payments are made, increasing the total amount of interest paid over the life of the construction loan. This extended interest-only period adds unexpected expenses to the project’s overall budget.

For construction loans with variable interest rates, fluctuations in market rates directly alter the amount of the monthly interest payment during the build phase. An increase in the benchmark rate, such as the prime rate, causes the interest portion of the payment to rise, while a decrease would lower it. Finally, the terms of the permanent loan, including its loan term (e.g., 15-year versus 30-year) and whether it has a fixed or adjustable rate, dictate the size and predictability of payments once the construction loan converts or is paid off. These factors collectively determine the financial outlay throughout the homebuilding process.