What Are the Requirements for a Construction Loan?

If you’re looking to build your dream house or tackle a renovation, you may want to secure a construction loan. This describes a sum of money you receive to help finance your building costs. But borrowing money in this way differs from getting a standard mortgage. Read on to find out the requirements for a construction loan. If you want help getting your finances in order to plan for this, consider working with a financial advisor.

How to Get a Construction Loan

Construction loans, particularly for large and costly building projects, require a great deal of pre-planning and vetting before a bank hands over the cash. There are several requirements a borrower must fulfill to assure the lender of a good investment.

1. A Qualified Builder and/or Construction Team

To finance a home building project through a bank, lender or other institution, you must first hire a reputable, licensed builder with official documentation. A qualified builder is a licensed contractor who has a proven reputation for building safe and enduring homes. You will need to provide a list of your chosen builder’s projects, both past and present. Many lenders will also ask you to provide a profit and loss report.

If you plan to build the house yourself without a professional builder, this will require a different kind of loan, but finding a lender, bank or institution to finance will prove exceedingly difficult. What’s more, it is often risky to forgo professional services, as you potentially jeopardize your construction project.

2. Detailed Description of the Construction Plan

Construction workers looking at a blueprint.

No established lender will hand over a substantial amount of funds for an unclear plan. Delineating a construction plan is one of the most important requirements of a construction loan.

To maintain a relationship with the bank, lender or institution, you must provide a detailed description of every aspect of the construction plan. These details, in one final copy, are commonly referred to as the blue book.

In addition to naming the suppliers and subcontractors, your project’s blue book must include several details, including:

The general timeline of the project
Floor plans
Ceiling heights
Type of home insulation
Cost of any wood used

You must also provide the profit projections for the future of the house and an inventory of all of the building materials.

3. Appraisal

The criteria for construction loans are based on the final home value. Therefore, an appraisal is a necessary requirement for a construction loan.

A licensed appraiser usually estimates a home’s value. This party will be responsible for reviewing the blue book and assigning value to the plot of land on which the home is being built. The appraiser then takes these calculations and measures them against comps, or comparable properties in similar locations.

Ultimately, the appraiser determines the value based on these comps. They are location-specific and market condition-dependent.

4. Sizable Down Payment

Another requirement for a construction loan is a sizable down payment. Because new construction is largely considered very ambitious, lenders will typically require a minimum of 20% down payment, with some lenders even asking for as much as 25% down.

This very high minimum helps ensure that you are sure of your project and ready to commit to it with an investment. Lenders do not want borrowers to abandon construction should things become difficult down the line.

These high down payments also serve to protect the bank, lender or institution in the event that the project does not end up being worth as much as the appraiser initially estimated.

Your ability to repay the loan is the final consideration. The lender will require proof of income and a high credit score to legitimize the loan.

Types of Construction Loans

Not all construction loans are structured the same way. Understanding the different types of loans available can help borrowers choose the loan that best matches their project goals, budget and repayment timeline.

Construction-to-Permanent Loan

This option automatically converts to a standard mortgage once the construction phase is complete. Borrowers only need to apply once and pay closing costs a single time.

During construction, payments are often interest-only based on disbursed funds. Once the home is completed, the loan converts into a traditional mortgage with regular principal and interest payments.

This structure is beneficial for borrowers who want long-term financing and predictability.

Construction-Only Loan

This loan type covers only the construction phase and must be paid off or refinanced into a mortgage when construction ends. It typically involves two separate loan applications and sets of closing costs.

Construction-only loans offer flexibility but can be more expensive due to duplicate fees and interest-rate risk between the two loan stages.

Owner-Builder Loan

Designed for individuals acting as their own general contractor, this loan allows the borrower to manage the building process without hiring a licensed builder.

These loans are difficult to qualify for, as lenders require extensive construction experience or credentials. Borrowers must demonstrate the ability to manage timelines, budgets and subcontractors effectively.

Renovation Loan

A construction loan may also be used for major renovations rather than building a new structure from the ground up. These loans typically include funds to purchase a property and cover substantial remodeling costs. Renovation loans are common for homebuyers purchasing fixer-uppers or homeowners making structural changes.

End Loan

An end loan refers to the permanent mortgage used to pay off a construction-only loan.

Borrowers who choose construction-only financing must apply for an end loan separately. These loans are subject to new underwriting, credit checks and appraisal conditions, and the final terms may differ from those assumed during the construction phase.

Evaluating these options based on project scope, timeline, and financial stability can help borrowers select the right loan structure for their needs. Each type involves different risks, costs and requirements, so working closely with a lender to compare terms is essential.

Bottom Line

A couple examining the construction work that they will have to complete.

Obtaining a construction loan is unlikely to be an easy pursuit, but it comes down to your commitment to the homebuilding process. Understanding how to get a construction loan hinges on these requirements. Make sure you have a reputable construction company and a description of the construction plan. Also, get an appraisal and ensure you have that down payment money at the ready.

Financial Management Tips

Construction loans can be complicated, but working with a financial advisor can make it much easier. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
A budget can help you save to build your dream house. Use SmartAsset’s budget tool to get started.