Construction Loans: Finance Your Custom Home Build

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Building a custom home is exciting, but coordinating the land, construction budget, builder, and mortgage can feel overwhelming.

A construction loan is short-term financing that pays eligible home-building costs through scheduled draws as construction progresses.

In this guide, we explain how construction loans work, the difference between one-close and two-close financing, common qualification requirements, and how to prepare for a custom build in Texas.

Key Takeaways

Purpose: Construction loans finance eligible costs associated with building a custom home rather than purchasing a completed property.
Funding: Loan proceeds are typically released in draws after construction milestones are completed and inspected.
Requirements: Approval commonly considers the borrower’s finances, builder qualifications, plans, budget, appraisal, land, and contingency reserves.
Timeline: The process includes pre-approval planning, project review, closing, construction draws, and conversion or refinancing into permanent financing.
Best For: These loans may fit borrowers building a primary residence, second home, or other eligible property under the selected program.

At Mission Mortgage of Texas, Inc. (NMLS# 207583), we help borrowers evaluate construction financing for projects in Austin, New Braunfels, San Antonio, and communities throughout Texas.

Quick Answers About Construction Loans

What does a construction loan pay for? It may cover eligible costs such as land, labor, materials, permits, and other items included in the approved construction contract and budget.
Is all the money provided at closing? Generally, no. Funds are released through scheduled draws tied to verified construction progress.
Are payments required while the home is being built? Often, borrowers make interest-only payments based on the amount drawn, but terms vary by program.
Can a self-employed borrower obtain construction financing? Potentially. The borrower must document qualifying income or meet the requirements of an eligible alternative-documentation program.
When should financing discussions begin? It is helpful to start before finalizing the land purchase, plans, or builder contract so the project can be structured around current lending guidelines.

How Does a Construction Loan Work?

A traditional mortgage finances a home that already exists. A construction loan finances a project that will become a completed home. Because the lender is funding work over time, underwriting evaluates both the borrower and the proposed construction project.

The lender typically reviews several connected parts of the transaction:

The borrower’s credit, income, assets, debts, and available reserves
The value and financing status of the building lot
The builder’s experience, licensing, insurance, and financial qualifications
The signed construction contract, plans, specifications, and detailed budget
The estimated value of the completed home
The planned construction schedule and draw process

After closing, money is normally placed under controlled disbursement rather than delivered as one lump sum. The builder requests funds as approved stages are completed. An inspection or progress report verifies the work before each draw is released.

A construction draw is a scheduled release of loan funds used to pay approved project costs after a defined stage of work has been completed. Common stages may include the foundation, framing, mechanical systems, drywall, interior finishes, and final completion. The exact schedule depends on the lender, builder contract, and project.

One-Close vs. Two-Close Construction Loans

The biggest structural decision is whether construction and permanent financing will be handled in one transaction or two. Neither format is automatically right for every project.

Feature	One-Close Loan	Two-Close Loan
Closings	Construction and permanent financing are arranged through one closing.	The construction loan closes first, followed by a separate permanent mortgage.
Permanent financing	Usually established before construction begins, subject to program terms.	Arranged near completion through a new loan application and closing.
Closing costs	May reduce duplicated closing expenses because there is one transaction.	May involve costs for two separate transactions.
Flexibility	Offers greater certainty but may provide fewer opportunities to change the permanent loan.	May offer more flexibility when selecting permanent financing after construction.
Requalification	Often limits the need for a completely separate permanent loan approval, although conditions may still apply.	Normally requires qualification for the new permanent mortgage.

Borrowers considering a custom build can review our construction home loan options to understand the general structures that may be available. Program terms, rates, fees, and qualification standards can change, so current information should always be verified before making project decisions.

What Do You Need to Qualify for a Construction Loan?

Construction loan underwriting is often more detailed than underwriting for a completed home. The lender must determine whether the borrower can support the financing and whether the proposed home can be completed within the approved budget and schedule.

Credit, Income, and Debt Review

Lenders commonly review credit history, monthly obligations, employment or income stability, liquid assets, and funds available for closing. Requirements vary based on loan type, occupancy, property type, and overall risk.

Self-employed borrowers may be asked for personal and business tax returns, year-to-date financial statements, business bank statements, or other records. Some borrowers may also explore a bank statement program when an eligible loan structure allows qualifying income to be evaluated through deposits rather than traditional tax-return calculations.

Down Payment, Land Equity, and Reserves

Required borrower funds vary considerably. The lender may calculate the required contribution using the project’s cost, completed value, land equity, loan program, and borrower profile.

If the borrower already owns the lot, documented equity may count toward the required investment in some programs. The lender will review the land’s current value, existing liens, purchase history, and how long the borrower has owned it.

Reserves are also important. A construction budget should include funds for approved contingencies because material prices, site conditions, and change orders can affect the final cost. The amount required varies by lender and scenario.

Builder Approval

Builder approval is separate from borrower approval. A lender may review the builder’s history, insurance, licenses where applicable, references, financial capacity, and current projects.

Owner-builder projects face additional restrictions and are not accepted by every lender. Before committing to a builder, borrowers should confirm that the builder can provide the documentation required by the construction loan program.

Plans, Specifications, and Budget

The project package generally needs detailed plans, specifications, a signed construction contract, and an itemized budget. Broad allowances without supporting detail can make appraisal and underwriting review more difficult.

The budget should identify materials, labor, allowances, permits, utility connections, site work, builder fees, and other proposed expenses. Items not approved before closing may need to be paid separately by the borrower.

How Is a Custom Home Appraised Before It Exists?

A construction appraisal estimates the property’s value as though the proposed home were complete. The appraiser reviews the lot, plans, specifications, square footage, finishes, and relevant comparable sales.

The “as-completed” appraised value helps determine how much the lender may finance, but it is not a guarantee of the home’s future market value. If the construction cost is higher than the supported value, the borrower may need to contribute additional funds, modify the plans, or consider another financing structure.

This can be especially important for highly customized homes or projects in areas where comparable sales are limited. For higher-value builds in Austin or other Texas markets, a jumbo home loan may be relevant if the permanent financing exceeds current conforming loan limits.

The Construction Loan Process Step by Step

Discuss the overall scenario. Review the proposed location, land status, estimated budget, income documentation, available funds, and preferred loan structure.
Complete pre-approval planning. The lender evaluates preliminary borrower qualifications before substantial money is committed to plans, deposits, or contracts.
Select an eligible builder. Confirm that the builder can meet the lender’s documentation and approval requirements.
Finalize the project package. Provide the contract, plans, specifications, budget, construction schedule, and other requested documents.
Order the appraisal and title work. The appraisal estimates the as-completed value, while title review identifies ownership, liens, easements, and other recorded matters.
Complete underwriting. The lender reviews both the borrower and the project before issuing final conditions and closing approval.
Close and begin construction. Construction should begin according to the loan documents and approved schedule.
Request and verify draws. Funds are released as milestones are completed and required inspections or documentation are received.
Finish the home. Final inspections, lien releases, occupancy documentation, and other completion items are collected.
Move into permanent financing. A one-close loan typically converts according to its terms, while a two-close structure requires a separate permanent mortgage closing.

Planning a Construction Project in Central Texas

Local conditions can affect the schedule and budget. Projects in Austin and Travis County may follow different permitting, utility, and inspection processes than builds in Hays County, Williamson County, Comal County, or Bexar County.

Site conditions also vary across the Texas Hill Country and the I-35 Corridor. Sloped lots, rock excavation, septic systems, wells, floodplain considerations, utility extensions, and municipal requirements can all influence the final project cost.

Before closing on land in areas such as Dripping Springs, Georgetown, Kyle, Buda, San Marcos, Round Rock, Leander, New Braunfels, or San Antonio, borrowers should investigate access, utilities, surveys, deed restrictions, and buildability. The same planning principle applies to construction projects in Houston and Harris County, where drainage and flood-zone review may be particularly relevant.

Common Construction Loan Mistakes to Avoid

Buying land before reviewing financing: Lot characteristics and existing land debt can affect the construction loan structure.
Using an incomplete budget: Missing site work, utility connections, permits, or finish allowances can create funding gaps.
Assuming every upgrade increases appraised value equally: Construction cost and market value are not always the same.
Changing plans without approval: Significant change orders may require lender review and additional borrower funds.
Ignoring the completion deadline: Delays may lead to extension requests, additional costs, or updated documentation.
Changing finances during construction: New debt, reduced assets, or changes in income can affect permanent financing, especially in a two-close transaction.

Prepare for Your Custom Home Financing Review

A productive first conversation does not require every final construction document. It helps to gather your recent income and asset records, estimated budget, land information, preliminary plans, and builder details. We can then compare possible structures and identify what may be needed before a full application.

Call, text, or email us to review your scenario, compare construction financing options, and understand the next steps. Starting with pre-approval planning can help you coordinate the land, builder contract, budget, and loan before construction begins.

Frequently Asked Questions

Can land equity be used toward a construction loan?

Land equity may count toward the required borrower investment, depending on the program and how the property was acquired. The lender will review the lot’s value, purchase history, ownership, and any existing liens before determining eligible equity.

What happens if construction costs exceed the approved budget?

Costs above the approved budget are not automatically added to the loan. The borrower may need to use available contingency funds, pay the difference, modify the project, or request lender approval for another solution.

Can a construction loan include a pool or detached structure?

Some programs may include eligible improvements when they are part of the original plans, contract, appraisal, and approved budget. Treatment varies by lender, and certain items may need to be paid for separately.

What happens if the completed home appraises below the project cost?

Financing is generally based on the program’s permitted calculation using cost and appraised value. A value shortfall may require additional borrower funds, revised plans, a lower budget, or a different loan structure.

Can construction begin before the loan closes?

Starting construction before closing can create eligibility, title, lien, appraisal, and reimbursement issues. Borrowers should obtain written guidance from the lender before authorizing site work, ordering materials, or making nonrefundable payments.

This is educational and not financial advice. Loan programs and guidelines can change. Talk with a licensed mortgage professional about your specific scenario.

About the Author

Mission Mortgage of Texas, Inc.

Your mortgage journey begins here. Getting started on the purchase or refinance of your home is just a few minutes away. No commitment needed.

Specializes in: Conventional, FHA, Non-QM

Licensed in: TX

→ Contact → (512) 3280-400

Company NMLS #207583