What’s a Construction Loan and How Does It Work?

What is a construction loan?

A construction loan is short-term financing that helps you pay for building a new home or doing a major remodel. Instead of getting all the money at once, you receive funds in stages as the work is completed. You usually pay interest only on the amount that has been drawn so far. When the project is finished, the loan is either paid off with a standard mortgage or converted into one. If you have asked yourself what is a construction loan and how it compares to a normal mortgage, the key difference is timing. A traditional mortgage pays for a finished home. A construction loan pays for the build as it happens.

Construction loans are popular for custom homes, large additions, and full gut renovations. The lender will review your plans, budget, and the builder you choose. They want to see that your project is realistic, that the contractor is qualified, and that the finished home will be worth at least what the total project costs.

How a construction loan works from start to finish

Understanding the flow helps you avoid surprises. Here is the plain-English overview of what is a construction loan in action.

• Pre-approval: You share your income, debts, and credit so the lender can set a budget range.
• Plans and budget: You and your builder provide detailed drawings, a line-item budget, and a construction timeline.
• Appraisal: The lender orders an appraisal based on the plans and the expected finished value of the home.
• Closing: You sign the construction loan and pay closing costs. If you already own the land, you can use its equity as part of your down payment.
• Draw schedule: Funds are released in stages, such as foundation, framing, mechanicals, drywall, and final completion.
• Inspections: Before each draw, an inspector confirms the stage is complete and matches the budget.
• Interest-only payments: During construction, you pay interest on the amount drawn so far.
• Completion and conversion: Once the home is ready and you have a certificate of occupancy, the loan is paid off or converts to a standard mortgage.

At every step, your choice of builder matters. Lenders prefer experienced, licensed contractors with a track record of completing similar projects on time and on budget.

Types of construction loans

Construction-to-permanent loan

This option gives you one closing up front for both the build and the final mortgage. You make interest-only payments during construction, then the loan converts to a standard long-term mortgage. It is often called a one-time-close loan and can save you money on closing costs and paperwork.

Construction-only loan

This is a short-term loan that covers the build. When the home is done, you take out a separate mortgage to pay off the construction loan. This path can give you flexibility to shop for the best long-term rate later, but it usually means two closings and two sets of closing costs.

Owner-builder loan

This is for experienced builders who plan to act as their own general contractor. Most lenders will not offer it to first-timers due to the higher risk. If you are not a seasoned builder, work with a licensed contractor instead.

Renovation construction loan

Some loans are built for major remodels or additions. They combine the cost of renovations with your mortgage, based on the expected value after the upgrades. If your project is a large kitchen expansion, second-story addition, or full home update, this can be a good fit.

Rates, costs, and payments

Compared to standard mortgages, construction loans usually have slightly higher interest rates. That is because building carries more risk than buying a finished home. Rates can be fixed or variable during construction, and you normally pay interest only on the amounts drawn.

Common costs to plan for

• Origination and underwriting fees
• Title updates and closing fees
• Inspections for each draw
• Appraisal based on the plans
• Builder’s risk insurance and liability insurance
• Permit fees and utility connection costs
• Contingency funds for surprises

Here is a simple example of how interest-only payments work. If your total loan is 500,000 but only 100,000 has been drawn, your monthly interest payment is calculated on the 100,000, not the full amount. As draws increase, your payment rises. When the house is complete and you convert to a regular mortgage, your loan becomes a standard principal-and-interest payment.

What lenders look for

If you want the smoothest path to approval, build a strong file. Here is what lenders usually review when deciding on what is a construction loan approval.

• Credit score and history: Many lenders want a 680 or higher, though some programs allow lower with conditions.
• Debt-to-income ratio: Your total monthly debts compared to your income. Lower is better.
• Down payment: Often 20 percent is ideal. Some programs allow less if you meet other requirements.
• Reserves: Extra savings to cover payments during construction and unexpected costs.
• Detailed plans and specs: Clear drawings, materials list, and a realistic budget.
• Experienced builder: Licensed, insured, and approved by the lender.
• Appraised value: The projected value of the finished home needs to support the loan amount.

Step-by-step timeline for a construction loan

1. Define your budget range and wish list.
2. Choose a contractor and gather bids. Elite Improvements can prepare a clear scope, timeline, and budget.
3. Get pre-approved to confirm your price range.
4. Finalize plans and specifications with your builder.
5. Submit your loan application with plans, budget, and builder credentials.
6. Appraisal ordered by the lender based on the plans.
7. Loan approval and closing on the construction loan.
8. Construction begins and the first draw funds foundational work.
9. Inspections occur at each stage. You sign draw requests as milestones are met.
10. Project completion, final inspection, and certificate of occupancy.
11. Loan converts to your long-term mortgage or is paid off with a new mortgage.

Risks and how to avoid them

Building or remodeling is exciting, but it involves moving parts. Use these tips to manage the common risks.

• Cost overruns: Include a 10 to 15 percent contingency in your budget. Ask your builder to flag any potential overruns early.
• Delays: Plan for weather and lead times. Build a cushion into the schedule.
• Change orders: Limit impulsive changes. If you do make changes, approve them in writing with pricing before work proceeds.
• Appraisal gap: If the final value comes in lower than expected, you may need to adjust finishes or bring extra cash. Have backup options ready.
• Contractor performance: Choose a licensed, insured contractor with strong references. Verify lien waivers with each draw.
• Interest rates: Ask about extended rate locks for the final mortgage. Understand any costs and rules for locking.

Construction loan vs renovation loan or HELOC

If you are weighing what is a construction loan against other options, here is the quick breakdown. Use a construction loan when you are building from the ground up or doing major structural work that requires staged funding and inspections. Use a renovation mortgage when you want to roll the cost of improvements into your home loan based on the post-renovation value. Consider a home equity loan or HELOC for smaller to mid-size projects when you have enough equity and prefer a simpler process.

For many homeowners in southeast Wisconsin, a renovation mortgage or HELOC can be perfect for kitchen remodels, bathroom updates, basement finishing, or a modest addition. If you are planning a full second story, a major addition, or a total gut renovation, a construction or renovation construction loan is often the right tool.

Can you use a construction loan for remodeling or an addition in Wisconsin?

Yes, as long as the project is large enough to require staged funding and inspections. Big additions, structural changes, and whole-home remodels often fit. Lenders will still ask for detailed plans, a realistic budget, the contractor’s credentials, permits, and a timeline. In some cases, a renovation loan product can be simpler and may offer more flexible terms for upgrades to an existing home.

Elite Improvements works with homeowners across Burlington and southeast Wisconsin to scope projects that match the right financing path. Whether you are adding a sunroom, expanding a kitchen, or finishing a basement, we can provide the documentation your lender needs and help you understand your best options.

Why choosing the right builder matters to your loan

Lenders approve both you and the builder. They want to see a contractor with the right licenses, insurance, and experience. A strong builder improves your chances of approval and helps keep draws moving. That makes your interest-only payments more predictable and reduces the risk of delays.

Elite Improvements is a family-owned remodeling and additions company based in Burlington, Wisconsin. We serve southeast Wisconsin with high-quality remodeling, additions, and exterior improvements. We are accredited by the BBB and Milwaukee NARI, and we are committed to clear communication, ethical practices, and craftsmanship. Our team provides detailed scopes, line-item budgets, and a draw-friendly schedule that helps your lender say yes and keep the project on track.

How Elite Improvements supports your construction or renovation loan

• Accurate planning: We help you define a realistic scope, materials plan, and timeline that aligns with lender requirements.
• Clear budgets: We create transparent line-item budgets that make appraisals and draw approvals easier.
• Permit and code expertise: Our local knowledge helps avoid delays. We coordinate permits and inspections that lenders expect.
• Draw coordination: We prepare documentation for each draw and provide updates so you always know where things stand.
• Quality control: Our project management helps pass inspections the first time, which can reduce costly rework.
• Ethical practices: As a BBB and Milwaukee NARI accredited company, we follow best practices that lenders and homeowners value.

Whether you are planning a new addition, a kitchen expansion, a basement transformation, or exterior upgrades, Elite Improvements can help you match your project to the right financing approach and deliver a smooth build. Visit eliteimproves.com or call 262-716-6663 to discuss your plans.

Tips to qualify and keep your project on budget

• Strengthen your credit: Pay down revolving balances, avoid opening new accounts, and correct any credit report errors.
• Right-size your budget: Leave room for a contingency. Avoid maxing out your approval.
• Choose fixed-price contracts when possible: This reduces surprises and helps the lender approve the budget.
• Document everything: Keep copies of permits, insurance, plans, and change orders.
• Lock key selections early: Cabinets, windows, and appliances can have long lead times. Early choices help avoid delays.
• Plan for living arrangements: Decide if you will stay in the home during a remodel or rent temporary housing. Add these costs to your budget.

Frequently asked questions about construction loans

How much down payment do I need?

Many lenders ask for 20 percent down. Some programs allow lower down payments if you meet credit and income guidelines. If you own the land, the equity can count toward your down payment.

How long does construction financing last?

Most construction loans last 6 to 18 months. Your builder sets a timeline and the lender expects completion within that window.

Can the loan include the land cost?

Yes. If you are buying land at the same time, the loan can cover it. If you already own the lot, its equity can help with your down payment.

Do I make payments on my existing mortgage during construction?

Yes, if you have one. Plan for those payments plus interest-only payments on the construction loan. Your lender may require cash reserves to cover this.

Will the loan cover soft costs like permits and design?

Often yes. Include them in your budget and confirm with the lender. Keep receipts and documentation.

Do I need mortgage insurance?

If your down payment is less than 20 percent, you may need private mortgage insurance depending on the program.

What happens if costs run over?

You may use a contingency fund, adjust selections, or bring in extra cash. Good planning with your builder helps minimize overruns.

Can I act as my own general contractor?

Most lenders prefer a licensed, insured general contractor with experience. Owner-builder loans are harder to qualify for and carry more risk.

Can I lock my final mortgage rate during construction?

Some lenders offer extended locks for the permanent loan. Ask about costs, how long the lock lasts, and what happens if the project runs late.

What credit score do I need?

Many lenders look for 680 or higher for the best terms, but some options exist for lower scores. A stronger score can lower your rate and fees.

Construction loan checklist

• Pre-approval letter and budget range
• Full plans, specs, and materials list
• Line-item cost breakdown
• Builder license, insurance, and references
• Permits or permit plan
• Draw schedule with milestones
• Contingency plan for overruns
• Insurance details for the build
• Living plan during construction if needed
• Backup options for rate locks and timelines

Working with Elite Improvements in southeast Wisconsin

Elite Improvements is proud to help homeowners in Burlington and across southeast Wisconsin plan and complete successful projects. We specialize in:

• Remodeling: Kitchen, bathroom, basement, master suite, and living room upgrades, including flooring, cabinetry, fixtures, and layout changes.
• Additions: Bathroom, bedroom, kitchen, home office, and sunroom additions, plus bump-outs for extra space.
• Exterior improvements: Residential roofing, siding replacement, and custom deck installations.

We believe that clear communication and quality craftsmanship make the financing process easier. Our detailed proposals help lenders approve your project, and our draw-ready schedules keep money flowing at each milestone. As a family-owned company accredited by the BBB and Milwaukee NARI, we are committed to ethical practices and exceptional service from start to finish.

Curious about what is a construction loan for your specific project? We can walk you through the options, tailor the scope to your budget, and coordinate with your lender. Contact Elite Improvements at 262-716-6663 or visit eliteimproves.com to get started.

Next steps

1. Decide on your must-haves and nice-to-haves.
2. Talk with a lender about what is a construction loan and your approval range.
3. Request a detailed proposal from a trusted contractor. Elite Improvements can provide plans, budgets, and timelines your lender will appreciate.
4. Build a realistic schedule with a contingency fund and a plan for inspections.
5. Start construction with confidence and stay in touch with your lender and builder at every stage.

When you know what is a construction loan and how it works, planning your custom home, addition, or major remodel becomes simpler. With the right team and a clear budget, you can bring your vision to life. Elite Improvements is ready to help you do it right the first time.