You found the perfect lot. You’ve worked with an architect, selected a builder, and you’re ready to create exactly what you want instead of settling for someone else’s vision. The construction loan approval comes through, and you feel like you’ve cleared the hardest hurdle.
You haven’t.
The part that catches most people off guard isn’t getting the construction loan—it’s what happens when you need to convert it into a permanent mortgage. This transition, often called a “construction-to-permanent” conversion, carries costs that rarely appear in the glossy brochures or initial loan estimates. And by the time you discover them, you’re already committed to a project that’s half-built.
The Belief That Gets People in Trouble
Most borrowers assume that a construction loan and its eventual conversion to a mortgage is one continuous process with predictable costs. They budget for the construction loan interest during the building phase and the mortgage payment afterward. What they miss is everything that happens in between.
The conversion itself isn’t free. Depending on your loan structure, you might face a second round of closing costs, a new appraisal, rate lock complications, and qualification requirements that have shifted since you started. Some of these costs are disclosed upfront but buried in paperwork. Others emerge only when the construction timeline stretches beyond what you planned.
The assumption of seamlessness is the expensive assumption.
Two Paths, Different Price Tags
Construction financing typically comes in two flavors: the single-close loan (construction-to-permanent) and the two-close loan (construction loan followed by a separate permanent mortgage). The names suggest the single-close option is simpler and cheaper. That’s partially true, but the nuance matters.
With a single-close loan, you lock in your permanent mortgage rate and terms before construction begins. You pay one set of closing costs. The construction phase rolls automatically into the permanent mortgage when building is complete. Sounds ideal—and it can be, if nothing changes.
But construction rarely proceeds without changes. If your build takes longer than expected, you might exceed your rate lock period. Extending that lock isn’t free. If material costs force change orders that increase your loan amount, you might need to requalify. If your financial situation shifts during the 8-12 month build—a job change, a new debt, a credit score dip—you could face problems even though you were already “approved.”
The two-close approach gives you flexibility but extracts a price. You’ll pay closing costs twice—once for the construction loan, once for the permanent mortgage. You’ll need two appraisals. You’ll qualify twice. If rates have risen by the time you’re ready to convert, you pay the higher rate. If rates have dropped, you benefit. It’s a gamble either way.
Neither option is universally better. But most borrowers don’t understand which risks they’re accepting until those risks materialize.
The Rate Lock Trap
Here’s where construction loans become genuinely treacherous: the rate lock.
When you buy an existing home, you lock your rate for 30-60 days while you close. With construction, you might need to lock for 9-15 months—covering the entire build plus a buffer. According to mortgage industry data, longer locks cost more—a 12-month lock might add 0.25% to 0.75% to your rate compared to a standard 45-day lock.
That’s not the trap, though. The trap is what happens when construction runs long.
Builders provide estimated timelines, but weather delays, permit issues, material shortages, and labor problems are common. The National Association of Home Builders reports that single-family home construction averages around 8-9 months, but delays of 2-4 months beyond initial estimates occur frequently. If your 10-month build becomes a 14-month build, your rate lock expires. You now face a choice: pay for an extension (typically 0.125% to 0.375% per month, according to lender disclosures) or let the lock expire and take current market rates.
If rates have risen substantially during your build, an expired lock can add tens of thousands to your lifetime mortgage cost. If you budgeted for an extension but need two or three of them, you’ve burned through that contingency. Some lenders cap the number of extensions they’ll allow.
The psychology makes this worse. By the time your lock is expiring, your house is nearly finished. You’re not going to walk away. The lender knows this. You have almost no negotiating leverage.
Understanding when to lock your mortgage rate becomes exponentially more complicated when you’re trying to predict what rates will do nearly a year into the future while also predicting whether your builder will hit their deadline.
The Second Appraisal Problem
Single-close loans typically include one appraisal upfront, based on the plans and specifications. The appraiser estimates what the completed home will be worth.
But here’s what they don’t always explain: many lenders require a second appraisal or at least a completion inspection when construction finishes. If the completed home appraises for less than projected—because the market shifted, because finishes were changed, or because the original appraiser was optimistic—you might face a gap.
If your loan was approved based on an anticipated value of $600,000 and the completed home appraises at $560,000, your loan-to-value ratio just jumped. You might need to bring cash to closing to make up the difference, or your rate and terms might change, or you might not qualify at all under the original terms.
This is rare in stable markets but becomes a real risk if you’re building during a period of price uncertainty. The longer your build takes, the more market conditions can shift.
Two-close loans face this more directly since the permanent mortgage appraisal happens after completion. But either structure can create an appraisal surprise that requires immediate cash you didn’t budget.
The Qualification Timing Nightmare
Mortgage qualification isn’t a one-time gate you pass through. With construction financing, you’re often re-verified multiple times.
Initial qualification happens when you apply. But before the construction loan closes, lenders verify employment and pull credit again. Before converting to permanent financing (or at completion for single-close loans), many lenders verify again.
A lot can happen in 12 months. Companies restructure. People change jobs for better opportunities. Medical expenses appear. Someone co-signs for a family member’s car loan. These normal life events can disrupt a conversion that seemed locked in.
The cruelest version: you leave one job for a higher-paying job during construction. More income should help, right? But if you switched from salary to commission, or moved from W-2 to self-employment, lenders might view you as higher risk despite higher earnings. Fannie Mae and Freddie Mac guidelines typically require two years of income history for variable income sources, meaning you might need two years in the new role to qualify at the same terms.
This connects to broader issues around debt-to-income ratios—the construction lending world applies these rules with even less flexibility because the loan itself is already considered higher risk.
The Interest Reserve Miscalculation
During construction, you typically don’t make full mortgage payments. Instead, you pay interest only on the amount that’s been drawn (disbursed to your builder). As construction progresses and more money is drawn, your interest payments grow.
Many construction loans include an “interest reserve”—money set aside to cover these interest payments during the build. It feels like free money because you’re not writing monthly checks. It’s not free. It’s coming from your loan proceeds, which means you’re borrowing money to pay interest on borrowed money.
If construction takes longer than planned, the interest reserve depletes faster than expected. You might need to start making out-of-pocket interest payments before the home is finished—while still paying rent or a mortgage on your current home. Or you might need to increase your loan amount to cover the additional interest, which affects your loan-to-value ratio and potentially your rate or qualification.
The interest reserve also reduces the money available for actual construction. If your budget is tight, an extended build can create a cash crunch where you’re choosing between finishing the home or covering interest payments.
Change Orders and Loan Modifications
Construction projects change. You decide you want the upgraded appliances. The builder discovers soil conditions require a different foundation. Material costs spike and substitutions are needed.
Small changes might be absorbed. But significant change orders—especially those that increase costs—often require loan modifications. Each modification can trigger additional fees, new documentation requirements, and fresh underwriting.
Some lenders are flexible about change orders up to a certain percentage of the original loan. Others treat any increase as a new loan application. If you’re already at the edge of qualification, even a $15,000 change order might require co-signer arrangements or additional collateral.
The timing is also brutal. Change orders often arise mid-construction when work must continue. You don’t have weeks to shop for better modification terms. You’re often stuck with whatever your current lender offers.
This is one reason why comparing new construction versus resale homes requires understanding not just the sticker price but the financing complexity that custom building adds.
The Completion Certificate Dance
Before your construction loan converts to a permanent mortgage, the lender needs assurance that the home is complete and habitable. This involves a completion certificate or certificate of occupancy from your local jurisdiction, often a final inspection by the lender’s representative, and confirmation that the builder has been paid and liens have been released.
Each of these can create delays. Inspectors find punch-list items that must be addressed. Builders dispute final payments. Subcontractors file liens over disagreements with the general contractor.
While this is sorted out, your rate lock is ticking. Your interest reserve is depleting. Your conversion is delayed.
The worst scenario involves a builder who hasn’t paid subcontractors. Those subcontractors can place liens on your property—a right established under mechanic’s lien laws that exist in all 50 states. Even if you’ve paid the builder in full, you might face liens you’re not responsible for but must clear before conversion. Some borrowers have ended up in legal battles with subcontractors they never directly hired.
A Framework for the Build-or-Buy Decision
Before committing to construction financing, run through these decision points:
Choose single-close if: You have a builder with a proven track record of on-time completion, your financial situation is stable and unlikely to change, you want cost certainty and can tolerate the upfront rate lock premium, and current rates are favorable enough that you want to lock them in.
Choose two-close if: You’re uncertain about construction timelines, your income or employment might change during the build, you want flexibility to shop for the best permanent mortgage after seeing your completed home, or you’re building in a volatile rate environment where waiting might work in your favor.
Reconsider building entirely if: Your contingency budget is less than 15% of total project cost (10% construction plus 5% financing), you’re at the edge of qualification with no room for income verification surprises, you can’t absorb 3-6 months of carrying costs if the build runs long, or your employment situation has any uncertainty in the next 18 months.
How to Protect Yourself
None of this means you shouldn’t build. It means you should build with eyes open and budgets padded.
Get explicit, written answers about conversion costs before committing to any construction loan. Ask specifically: What happens if construction takes four months longer than planned? What does a rate lock extension cost, and how many can you purchase? What triggers re-qualification, and what documentation will you need?
Build a contingency into your budget specifically for financing surprises—not just construction surprises. A 10% construction contingency is standard advice. Consider another 2-3% for financing contingencies: rate lock extensions, additional appraisals, legal fees for lien resolution.
Choose your builder carefully, with financing implications in mind. A builder with a strong track record of on-time completion reduces your rate lock risk. A builder who pays subcontractors promptly reduces your lien risk. References from recent clients who built with similar financing structures are more valuable than general testimonials.
If possible, maintain stable employment and avoid new debts during the build. This isn’t always realistic—life happens—but understanding that any financial change could affect your conversion helps you make informed decisions.
The Question You Should Be Asking
Construction lending complexity exists because building a home is genuinely riskier for lenders than financing an existing home. The house might not be completed. The builder might fail. The value might not materialize as expected. Lenders price for this risk and build in protections, which become your costs.
For many people, these costs are worth it. Building exactly what you want, where you want it, can be deeply satisfying in ways that buying someone else’s compromises never matches.
But you should enter this process knowing the true price—not just the construction cost or the interest rate on the brochure, but the conversion costs that accumulate when reality diverges from the plan.
The decision about whether to build isn’t just “can I afford this house?” It’s also: can I afford the financing complexity, the timeline uncertainty, and the costs that emerge when those uncertainties resolve unfavorably?
And if building still makes sense, the next question becomes: should you build now, or would buying an existing home and planning to build later—once you’ve accumulated more financial cushion—give you a safer path to the home you really want?