How to Pay for a Custom Home: Construction Loans and Draws

Most people arrive at their first custom home already knowing how a mortgage works. A construction loan isn’t that, and the differences are the kind that affect your monthly cash flow and your closing timeline.

The short version is that nobody hands you the full amount up front. The money comes out in stages as the house gets built, a third party verifies each stage, and you pay interest only on what’s actually been released. Once you understand that shape, the rest of it makes sense.

This is general guidance, not lending advice. Terms vary by lender and by what the market is doing, so confirm the specifics with yours.

The short answer

A construction loan releases money in four to six draws as the build hits milestones. Each draw requires an inspection before funds are released. You pay interest only on the amount drawn so far, which means your payment starts small and climbs as the house goes up. Most construction loans here run on a 12-month clock, and most lenders will want to see your builder’s contract, plans, and budget before they’ll approve anything.

One-time close or two loans?

There are two structures, and it’s worth knowing which one you’re being offered.

One-time close (also called single close or construction-to-permanent) is one loan, one closing, one set of closing costs. It funds the build, then converts to your permanent mortgage when the house is done. You lock your permanent rate at the beginning, which is either an advantage or a disadvantage depending on where rates go while you’re building.

Two loans means a short-term construction loan, then a separate refinance into a permanent mortgage at completion. Two closings, two sets of costs, and you’re exposed to whatever rates are doing at the end. The upside is flexibility, and sometimes better construction terms.

Neither is automatically right. Ask both questions of any lender you talk to: what happens to my rate, and how many times am I paying closing costs.

How draws actually work

This is the part that surprises people, so here’s the mechanic in order.

1. A milestone gets completed. Foundation poured. Framing and roof done. Rough-ins passed. Drywall up. Finishes in.
2. Your builder requests a draw for the work covered by that stage.
3. An inspector verifies it. Usually the lender’s inspector, physically on site, confirming the work is actually in place.
4. The lender releases funds, typically within a few days to a week of the inspection clearing.
5. Your interest-only payment goes up, because there’s now more money outstanding.

Most builds run four to six draws. A common shape looks like this, though every lender structures it differently:

Stage	Share of the loan
Foundation and site work	10% – 20%
Framing, roof, windows	30% – 40%
Rough-ins, mechanicals, drywall	20% – 30%
Finishes and completion	10% – 20%

Two things to notice. The draw schedule follows completed work, not the calendar, which is exactly how it should be. And the biggest chunk lands in the middle, which means your carrying cost ramps up hardest right around the time you’re also making a lot of selections.

What interest-only actually costs you

You pay interest on the balance drawn, not the loan amount. So if your loan is $1.5M and only $200,000 has been released, you’re paying interest on $200,000.

That’s genuinely helpful early. It also means your payment roughly doubles and doubles again over the course of the build, and by the last few months you’re paying interest on close to the whole thing. Ask your lender to walk you through the projected payment at month 3, month 8, and month 12. Seeing those three numbers side by side is worth more than any general explanation, including this one.

Also ask whether the loan carries an interest reserve, which is money borrowed up front to cover those payments. Some people want it so they aren’t paying rent and construction interest out of pocket at the same time. Some would rather not borrow money to pay interest on borrowed money. Both positions are reasonable. Just know which one you’ve got.

Your land is usually the down payment

If you already own your lot, most lenders will count that equity toward your down payment, sometimes covering it entirely. If you’re buying land and building, you’ll generally need the land paid for or rolled into the construction loan.

This is one more argument for reading what to check before you close on a parcel, because the lender is going to appraise that ground and it has to support the loan.

What your lender will want from your builder

Lenders underwrite the builder almost as carefully as they underwrite you. Expect them to ask for:

• A signed contract with a defined scope and price
• A complete set of plans and specifications
• A detailed budget broken out by category
• Your builder’s license, insurance, and often their financials or references
• An appraisal based on the plans, which has to support the loan amount

Here’s where the pricing model matters in a practical way. A fixed price contract gives an underwriter exactly what they need: one number, defined scope, and a builder who’s contractually on the hook for the overage. Cost plus gives them an estimate, which is harder to underwrite and sometimes means a bigger contingency requirement or a lower loan amount. That’s not the reason to pick a contract type, but it’s a real consequence, and it’s covered in more depth in fixed price vs. cost plus.

The 12-month clock

Most construction loans in this market run on a 12-month construction period. That’s a real constraint worth thinking about early, because a custom home on a difficult site can take longer than that once you count weather and permit review.

Ask two questions before you sign:

• What happens if we go past 12 months? What’s the extension process, what does it cost, and is it automatic or discretionary?
• Does the clock start at closing or at groundbreaking?

The answers vary, and the difference between those two start dates can be a couple of months of runway. If your build is likely to be tight against the clock, it’s better to have that conversation with your lender at the beginning than in month eleven. Our take on realistic durations is in how long a custom home actually takes.

Questions worth asking your lender

• Is this a one-time close or will I refinance at the end?
• How many draws, and what triggers each one?
• Who inspects, and how long from inspection to funds in the builder’s hands?
• Is there an interest reserve, and is it optional?
• What’s the construction period, and what happens if we run past it?
• What are the fees on each draw?
• Do you hold retainage, and when is it released?

That last one catches people. Some lenders hold back a percentage of each draw until the certificate of occupancy is issued. It’s a normal practice, but it affects your builder’s cash flow, and you want everyone aware of it going in rather than discovering it at the first draw.

The bottom line

A construction loan is a staged, inspected, interest-as-you-go instrument, and once you see it that way it stops feeling strange. The two things that make it go smoothly are a builder whose draw requests line up with work that’s genuinely complete, and a lender who tells you the full shape of the thing before you sign.

If you want to talk through how a draw schedule would line up with your specific build, or you’d like us to work with a lender you’re already talking to, get in touch. And if you’re still working out the total number, start with what it really costs to build here.