The short answer: a construction loan is a short-term line of credit, usually 12 to 18 months for a custom home, that pays your builder in stages called draws as the work is completed and inspected. You pay interest only on what has been drawn, not the full amount, and when the home is finished the balance is paid off by (or converts into) an ordinary 30-year mortgage. Expect to bring about 20 percent equity, which can be the lot you already own, and expect the lender to approve your builder, the plans, and the budget before it approves you. In the Pikes Peak region most custom homes we build are above the 2026 conforming limit of $832,750, which makes them jumbo construction loans, and that narrows the field of lenders to the local banks and credit unions that keep these loans on their own books.
This article began in 2014 as a guest post from a Colorado Springs construction lender. I have rewritten it from the builder's side, with what has changed since: one-time-close loans are now the common product, government-backed construction loans exist, the conforming limit has nearly doubled, and the questions we answer in our first meeting with a client's lender have not changed at all.
How a construction loan differs from a mortgage
A mortgage is a loan against a house that already exists. The lender appraises it, funds the whole amount at closing, and you pay principal and interest for 30 years. A construction loan is a loan against a house that does not exist yet, so everything about it is structured around that risk. It is short, interest-only, and disbursed in pieces. The lender underwrites the project as much as the borrower: who is building it, for how much, from what plans, on what schedule, and what will it appraise for when it is done.
The appraisal is the piece that surprises people. The appraiser values the finished home from your plans, specifications, and construction contract, plus the lot, and the lender lends a percentage of the lesser of that number or your actual cost. If your contract is $900,000 on a $250,000 lot and the home appraises at $1,150,000, the loan is based on $1,150,000. If it appraises for less than cost, which happens with very large or unusual homes in rural areas, the gap comes out of your pocket.
Think of it as a large credit card with an inspector attached
The old comparison still works. You are approved up to a limit, you only pay interest on what you have used, and the balance comes due when the house is finished. The difference is who gets to swipe it. Draws are tied to milestones in a schedule the lender and builder agree to up front, typically five to seven of them: foundation, framing and dry-in, mechanical rough-ins, drywall and interior finish, and completion. Before each draw the lender sends an inspector to confirm the work is in place, the title company checks for liens and collects lien waivers from the subcontractors who were paid from the previous draw, and only then does money move. A good builder submits clean draw packages on a predictable rhythm. A bad one is why this process exists.
Two features worth asking any lender about. An interest reserve builds the construction-period interest into the loan itself, so you are not writing a growing monthly check while also paying rent or a mortgage somewhere else. And a contingency reserve, usually 5 to 10 percent of the construction budget, is held inside the loan for changes and surprises. Most lenders now require one. We think they are right to.
One-time close or two-time close
This is the first real decision, and the market has moved since the original article was written.
A two-time close is a construction loan from one lender followed by a separate permanent mortgage, from the same lender or any other, when the house is done. You pay two sets of closing costs and qualify twice, but you shop the permanent rate at the end and you have flexibility if the budget or timeline moves. This is what most custom-home lenders in Colorado Springs offered a decade ago.
A one-time close, also called construction-to-permanent or single close, sets up the construction loan and the mortgage in one closing. When the house is finished the loan simply converts. One set of closing costs, one qualification, and, importantly, you are no longer exposed to the risk that your credit or income looks different 14 months from now. The historical knock on these was rigidity: a fixed loan amount and a fixed completion date. Most lenders have softened that. Many now allow a rate float-down at conversion, a modification if the budget changes inside the contingency, and an extension if the schedule slips.
Our view, as the builder: for a design-build custom home, where the price is fixed in the contract before you close on the loan and the schedule is realistic, a one-time close is usually the better product in 2026, and it is the only way to use an FHA, VA, or USDA construction loan, which all run as single close. The exceptions are homes where you genuinely expect the scope to grow, or where you intend to pay the construction loan off with the sale of another property. Then a two-time close keeps your options open. Either way, the lender will want the same things from us, which brings us to qualification.
What you need to qualify
The borrower side looks like any mortgage with the dials turned up: a solid credit score (most construction lenders want 680 or better, and jumbo programs often want more), a debt-to-income ratio that works with the new payment, cash reserves, and documented income. The project side is where a construction loan is different.
- Equity. Conventional construction lenders generally lend to 80 percent of value, so plan on 20 percent of the total project cost. If you already own the lot, its appraised value counts toward that equity, and if you have owned it for a year or more most lenders use the appraised value rather than what you paid. On a $1,000,000 project with a $250,000 paid-off lot, your cash contribution may be close to zero. VA one-time-close loans can go to 100 percent for eligible veterans, which matters in a military town, and FHA single-close loans go to 96.5 percent, though both carry loan limits that most custom homes here exceed.
- An approved builder. The lender will ask us for our license, insurance certificates, references, a financial statement, and sometimes a history of completed projects. A builder who cannot produce that package quickly is a warning sign, for the lender and for you.
- Plans, specifications, and a contract. Not a sketch. Permit-ready plans, a specification sheet detailed enough for an appraiser to price, a fixed-price or clearly defined cost-plus contract, a line-item budget, and a construction schedule. This is why our process puts design and pricing before financing: the lender cannot say yes to a number nobody has agreed on.
- A contingency. Held in the loan or in your own account, but it needs to exist. More on that below.
Conforming, jumbo, and why it matters in Colorado Springs
A conforming loan is one that Fannie Mae and Freddie Mac will buy. For 2026 the baseline one-unit limit is $832,750 (it was $417,000 when the original article was written), and El Paso and Teller counties sit at the baseline, not in a high-cost tier. Anything above that is a jumbo loan, and most of the homes we build are. Jumbo construction loans are portfolio loans: the bank keeps them rather than selling them, so it sets its own rules and its own rate, and it tends to want more equity, more reserves, and a better credit profile. The practical effect is that your lender choices shrink to the Front Range community banks and credit unions that actually do this, and the national online lenders mostly drop out. We work with a handful of them regularly and are happy to introduce you, with no obligation to use any of them.
Do you have to sell your current home first?
It depends on your debt-to-income ratio, and on nothing else. If your current home is paid off, there is no conflict. If you carry a mortgage on it, the lender has to be satisfied you can make that payment and the new construction loan payment at the same time, for the whole build. Some clients qualify for both comfortably and sell after they move. Some sell first and rent for a year, which is less convenient but turns the equity into a down payment and removes the question. Others use a bridge or home equity line against the current home for the equity requirement and pay it off at the sale. All three work. What does not work is deciding mid-build. Settle this with your lender before you close on the land.
Five mistakes we still see
The original lender's list has held up for twelve years. I have kept it and added what we see from the job site.
- Thinking you need to own land first. You do not. The lot can be rolled into the construction loan, and often should be: a separate lot loan usually carries a higher rate and a shorter term.
- Letting the scope outrun the approval. The lender said yes to a $900,000 house. If the design grows to $1,300,000 over the next six months, the approval does not grow with it. Keep your lender in the loop as the plans evolve, and work with a builder who prices as you design rather than at the end.
- A spending spree after approval. A new truck between construction closing and permanent closing changes your ratios. On a two-time close that can cost you the mortgage; on a one-time close it can still trip a re-verification. Buy the truck after you move in.
- A missed payment. One late mortgage payment during the build dropped a client's score far enough that the permanent loan died, even with a large income and plenty of equity. Set every existing payment to autopay before you break ground.
- No contingency. We hit a boulder the size of a car below grade on a Broadmoor Bluffs lot once; blasting it out added about $15,000. Rock, groundwater, a soils report that calls for a deeper foundation, a well that needs a cistern, and plain changes of mind all cost money. Plan on 5 to 10 percent of the construction budget, inside the loan or in a savings account. A contingency you do not spend goes back in your pocket. A contingency you do not have takes the fun out of building.
Where the builder fits in
Lenders approve projects, not just people, so the builder is part of your loan application whether anyone says so or not. We talk to our clients' lenders early, usually before the loan application goes in, so the budget, schedule, draw structure, and insurance line up with what the bank expects and nobody is surprised at the first draw. If you are at the stage of choosing a lender, start with one that funds custom homes in this area every month, ask how many draws they expect and how long an inspection takes to turn, and ask what happens if the schedule runs long. The answers tell you a lot.
If you want to talk through how financing fits with design and pricing on a specific project, see how our process works, or read what a custom home actually costs to build in Colorado so your loan conversation starts from a real number.
