How Much Does a Construction Loan Cost? A Detailed Look at Fees and Rates

Construction loans allow you to finance the building of a new home from the ground up. But these specialized loans come with higher costs than traditional mortgages. So how much more can you expect to pay for a construction loan?

In this comprehensive guide, we’ll break down the various fees and costs associated with construction loans. We’ll also look at current interest rates and factors that affect pricing.

Construction Loan Interest Rates

The interest rate is typically the largest cost associated with any type of loan. Construction loan rates are based on the Prime Rate, which is currently around 7%. So you can expect to pay a higher rate for a construction loan than a traditional 30-year fixed mortgage.

As of December 2022 average construction loan rates range from 8% to 10% for a 1-year adjustable rate. By comparison average 30-year fixed mortgage rates are around 6.5%.

Construction loans carry higher interest rates for a few key reasons:

• Shorter Term – Construction loans are designed to be short-term, usually around 6-12 months. Shorter loan terms correlate with higher rates.

• Variable Rate – Most construction loans have a variable rate that fluctuates with the Prime Rate. Variable rates are riskier for lenders.

• No Collateral – There’s no actual house as collateral until the construction is complete This makes construction loans riskier

• Custom Project – Since each homebuild is unique, it’s harder for lenders to accurately estimate costs and risks.

Upfront Fees

In addition to higher rates, expect to pay various upfront fees when taking out a construction loan. Common fees include:

• Origination Fee – Usually 1-2% of the loan amount. This covers processing costs.

• Application Fee – Around $100-500 to apply for the loan.

• Commitment Fee – 0.5-1% of the loan amount. For reserving the funds.

• Title Search – $300-1,000 for title document retrieval.

• Appraisal Fee – $300-500 to assess the property value.

• Credit Check – $50-100 per person to check credit reports.

In total, you’ll likely pay around 2-5% of the loan amount in upfront fees. On a $300,000 construction loan, expect around $6,000-$15,000 in fees.

Interest Reserves

Another cost unique to construction loans is building an interest reserve into the loan amount. This reserve covers your interest-only payments during the construction period.

Lenders will estimate your per-month interest using the projected rate and loan amount. They’ll then multiply this by the number of months needed to complete construction.

For example, say you get a $300,000 construction loan at 10% interest for a 12 month build. Your lender would estimate:

• Interest per month = $300,000 x 0.10 / 12 = $2,500
• Monthly interest x 12 month build = $30,000 reserve

This $30,000 would be added to the loan balance, bringing the total loan amount to $330,000. Having this reserve ensures you can make the interest-only payments during construction.

Draw Fees

Construction loans are disbursed incrementally as certain project milestones are met. These incremental disbursements are called “draws.”

Each draw will incur a small processing fee, around $100-$300 per draw. With about 5-10 draws on average, you’ll pay $500-$3,000 in total draw fees.

Inspection Fees

Lenders will require professional inspections before approving each draw. Typical inspections include:

• Foundation inspected before concrete is poured
• Framing inspected before drywall goes up
• Final inspection when construction is complete

Expect to pay $200-$500 per major inspection. With 2-3 big inspections, budget around $600-$1,500 for inspection costs.

Land Acquisition

If you haven’t already purchased land, the loan funds can cover this cost. Budget around 10-30% of the total construction loan amount for land acquisition.

Rural or undeveloped land can be purchased for as little as $5,000. But plot prices surge above $100,000 in high-demand areas. Do your research to estimate land costs for the location you want to build in.

Closing Costs

Finally, account for standard closing costs associated with any mortgage. Expect to pay around 2-5% of the loan amount in various title fees, recording fees, taxes, and more.

On a $300,000 construction loan, closing costs add an extra $6,000-$15,000 in upfront costs.

Construction Loan Cost Example

Let’s look at a hypothetical construction loan amount of $300,000. Here are realistic estimates for the total fees and costs:

• Loan Origination Fee: $6,000
• Upfront Fees: $2,000
• 12 Month Interest Reserve: $30,000
• 5 Draw Fees: $1,500
• 3 Inspection Fees: $1,500
• Land Purchase: $60,000
• Closing Costs: $9,000
• Total Upfront Costs: $110,000

With $110,000 in fees/reserves, the total construction loan amount would be $410,000.

On a $300,000 baseline loan, that equates to nearly 37% of the loan amount in additional costs.

Ways to Reduce Construction Loan Costs

While construction loans carry higher costs, there are some ways to reduce the impact:

• Shop Around – Compare loan costs quotes from multiple lenders. Local banks and credit unions may offer lower rates.

• Shorten Timeline – Minimize the interest reserve by condensing the project timeline. But don’t rush at the expense of quality.

• Lower Rate Type – See if a lender can offer a lower fixed rate instead of a higher variable rate.

• Buy Land Outright – If you can pay cash for the land upfront, you’ll avoid financing costs.

• Bigger Down Payment – Put down 20-30% if possible to lower the loan amount and fees.

• Home Equity Loan – Consider a HELOC instead if you already own the land or are renovating.

The Bottom Line

Construction loans provide key financing to build a custom home but come with costs above a typical mortgage. Make sure to budget for fees of up to 5% of the loan amount along with a higher variable interest rate. And utilize any opportunities to reduce costs where possible. With careful planning and comparison shopping, you can keep your construction loan affordable.