We are an independent, advertising-supported comparison service. Our goal is to help you make smarter financial decisions by providing you with interactive tools and financial calculators, publishing original and objective content, by enabling you to conduct research and compare information for free – so that you can make financial decisions with confidence.
Bankrate has partnerships with issuers including, but not limited to, American Express, Bank of America, Capital One, Chase, Citi and Discover.
Construction loans are a great option for financing the building of a new home or major renovations on an existing property However, construction loans tend to have higher interest rates than traditional mortgages In this article, we’ll take a closer look at typical construction loan rates in 2023 and what affects them.
What is a Construction Loan?
A construction loan is a short-term loan used to finance the construction or major renovation of a home. The funds are disbursed in stages as construction milestones are met. Once construction is complete, the construction loan transitions into permanent financing with a traditional mortgage.
Construction loans allow you to build and move into a custom home without having to pay for the entire project upfront. However, they tend to have higher interest rates than traditional mortgages since the lender is taking on more risk by funding a project that doesn’t yet exist.
Typical Construction Loan Rates
Construction loan rates are usually based on the prime rate plus a margin determined by the lender. According to Bankrate, here are some typical construction loan rates as of January 2023:
- 5/1 adjustable-rate mortgage (ARM): 6% – 7%
- 7/1 ARM: 6.125% – 7.125%
- 10/1 ARM: 6.25% – 7.25%
These rates can fluctuate daily with the market. They are also usually 0.5 to 2 percentage points higher than rates for traditional mortgages.
For example, the average 30-year fixed mortgage rate in January 2023 is around 6.5%. A 30-year construction loan rate may be around 7.5% to 8.5% during the same period.
What Impacts Construction Loan Rates?
Several factors determine the interest rate lenders will offer on a construction loan:
Credit Score
As with any loan, your credit score is a major factor. Borrowers with higher credit scores generally qualify for lower rates. Many lenders require a minimum score of 680 to 700 for a construction loan.
Loan-to-Value (LTV) Ratio
Your LTV ratio compares the amount you wish to borrow to the completed value of the home. The lower the LTV, the less risk for the lender. Expect lower rates if you put 20% or more down.
Loan Size
Loans under $100,000 tend to have higher rates since they are less profitable for lenders. Jumbo loans over $510,400 also often have higher rates.
Construction Costs
Higher construction costs mean more risk for lenders, which may translate to a higher rate. Provide detailed plans and a fixed-price contract from your builder to get the best rate.
Interest Rate Environment
Like all loans, construction loan rates rise and fall with the overall interest rate environment. Rates tend to be lower when the economy is weaker.
Relationship Discounts
Some lenders offer discounted rates if you have an existing relationship with them, such as a checking account. This rewards loyalty while allowing cross-selling of products.
Loan Program
Government-backed loans like FHA, VA, and USDA construction loans potentially offer lower rates than conventional construction loans. However, they have stricter eligibility requirements.
How to Get the Best Construction Loan Rate
While construction loan rates are often higher than traditional mortgages, here are some tips for getting the lowest rate possible:
-
Shop around – Compare quotes from multiple lenders, including small local banks, credit unions, and online lenders.
-
Improve your credit – Work on increasing your credit score before applying. Pay down debts and correct any errors on your credit reports.
-
Put down 20% or more – A higher down payment lowers the LTV ratio and risk for lenders.
-
Limit construction costs – Keep your budget reasonable to avoid exceedingly high loan amounts.
-
Lock in early – You can lock in an interest rate after loan approval. Locking in sooner protects against rate increases.
-
Apply relationship discounts – See if you qualify for lower rates through existing accounts with a lender.
-
Explore loan programs – Government construction loan programs may offer below-market rates if you qualify.
The Transition to Permanent Financing
One thing to keep in mind is that construction loans aren’t meant to be long-term financing. Within 6 to 12 months after the project’s completion, you’ll need to transition to permanent financing.
Many lenders let you lock in mortgage rates for the permanent loan upfront. This provides payment stability once the construction loan transitions.
For the permanent loan, shop around just as you did for the initial construction financing to find the best interest rate and terms. You can often get a lower rate once the property is actually completed.
The Bottom Line
Typical construction loan rates today range from 6% to 8% depending on loan type, credit score, down payment amount, and other factors. While construction loan rates are higher than traditional mortgages, it’s an understandable trade-off that allows you to build a custom home matched to your needs and preferences. Carefully shopping around, improving your credit, and making a sizable down payment can help you secure the most favorable construction loan rate possible.
Construction loans vs. traditional mortgages
Beyond the cost and repayment timeline, construction loans and mortgages have a few main differences:
- The funds distribution: Unlike mortgages and personal loans that provide funds in a lump-sum payment, the lender pays out the money for a construction loan in stages as work on the new home progresses. These draws tend to happen when major milestones are completed — for example, when the foundation is laid, or the framing of the house begins.
- The repayments: With a mortgage, you start paying back the principal and interest right away. With construction loans, your lender will typically expect you to make interest payments only during the construction stage. Additionally, borrowers are typically only obligated to repay interest on any funds drawn to date until construction is completed.
- Inspection/appraiser involvement: While the home is being built, the lender has an appraiser or inspector check the house during the various construction stages. As the work is approved, the lender makes additional payments to the contractor, known as draws. Expect to have between four and six inspections to monitor the progress.
- Requirements: Construction loan requirements include being financially stable and having the ability to make a down payment. Lenders also want to see a construction plan, which you can read more about below.
- Interest rates: Construction loan interest rates are typically higher than traditional mortgage rates. This is often because you’re not providing collateral to back the loan, which means the lender is taking on more risk.
How We Make Money
The offers that appear on this site are from companies that compensate us. This compensation may impact how and where products appear on this site, including, for example, the order in which they may appear within the listing categories, except where prohibited by law for our mortgage, home equity and other home lending products. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you.
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Heres an explanation for . Bankrate logo
Founded in 1976, Bankrate has a long track record of helping people make smart financial choices. We’ve maintained this reputation for over four decades by demystifying the financial decision-making process and giving people confidence in which actions to take next.
Bankrate follows a strict editorial policy, so you can trust that we’re putting your interests first. All of our content is authored by highly qualified professionals and edited by subject matter experts, who ensure everything we publish is objective, accurate and trustworthy.
Our mortgage reporters and editors focus on the points consumers care about most — the latest rates, the best lenders, navigating the homebuying process, refinancing your mortgage and more — so you can feel confident when you make decisions as a homebuyer and a homeowner. Bankrate logo
Bankrate follows a strict editorial policy, so you can trust that we’re putting your interests first. Our award-winning editors and reporters create honest and accurate content to help you make the right financial decisions.
We value your trust. Our mission is to provide readers with accurate and unbiased information, and we have editorial standards in place to ensure that happens. Our editors and reporters thoroughly fact-check editorial content to ensure the information you’re reading is accurate. We maintain a firewall between our advertisers and our editorial team. Our editorial team does not receive direct compensation from our advertisers.
Bankrate’s editorial team writes on behalf of YOU – the reader. Our goal is to give you the best advice to help you make smart personal finance decisions. We follow strict guidelines to ensure that our editorial content is not influenced by advertisers. Our editorial team receives no direct compensation from advertisers, and our content is thoroughly fact-checked to ensure accuracy. So, whether you’re reading an article or a review, you can trust that you’re getting credible and dependable information. Bankrate logo
Construction Loans: What They Are and How They Work (IN DETAIL)
FAQ
How much interest is on a construction loan?
Are construction loan rates higher than mortgage rates?
What is the interest rate for construction loans in 2024?
Is a construction loan a good idea?
What is a good interest rate for a construction loan?
At the time of writing this, depending on the lender, 4.5 percent is a typical interest rate for construction loans. That’s about one percent higher than a typical rate for mortgage loans during the same time period. What is a good credit score to get a construction loan?
How much money do you need for a construction loan?
You should have enough income to cover payments on your current debts and the new construction loan. Lenders typically require a DTI ratio no higher than 45% for construction loans. Down payment of at least 20%. Borrowers typically need a down payment of at least 20% for a construction loan, but this can vary by lender.
Are construction loan rates variable?
Interest rates on construction loans are variable, meaning they can change throughout the loan term. But in general, construction loan rates are typically around 1 percent higher than mortgage rates. With a construction loan, you typically don’t receive the full loan amount upfront.