If you're planning to build a home instead of buying one that's move-in ready, you'll need to choose between two very different types of financing: a construction loan and a traditional mortgage. Understanding the difference is crucial to securing the right loan for your needs, budgeting correctly, and avoiding delays. This guide will break down the key differences between a construction loan vs. mortgage, how each one works, and which one might be right for your project.

What is a construction loan?

A construction loan is a short-term loan used to finance the cost of building a new home or completing major renovations on an existing property. Unlike a mortgage, which provides a lump sum at closing, a construction loan is paid out in draws as different stages of the project are completed.

Borrowers typically make interest-only payments during the construction phase. Once the home is complete, the loan is either paid off or converted into a traditional mortgage. You can guarantee you’ll have the latter option by choosing a construction-to-permanent loan (more on that below).

What is a mortgage?

A mortgage is a long-term loan used to purchase a fully built home. You receive the entire loan amount upfront and repay it over time, typically 15 to 30 years, through monthly payments that include principal and interest (and, in most cases, other recurring costs like taxes and insurance).

Mortgages are designed for homes that are already built and ready for occupancy. Unlike construction loans, they don’t involve progress payments or multiple inspections.

Construction loan vs. mortgage: Key differences

When comparing a construction loan vs. mortgage, the biggest differences are in the timing, structure, and qualification process. Here’s how they stack up:

Loan purpose:

• Construction loan: Finances the building or renovation of a home
• Mortgage: Finances the purchase of a completed home

Loan term:

• Construction loan: Short-term (usually 6–18 months)
• Mortgage: Long-term (typically 15–30 years)

Disbursement method:

• Construction loan: Funds released in stages (draws) as construction progresses
• Mortgage: Funds disbursed in full at closing

Payments:

• Construction loan: Usually interest-only during construction, based on amount drawn
• Mortgage: Monthly payments with principal and a fixed or adjustable interest rate, depending on the loan terms

Collateral:

• Construction loan: Often secured by the future value of the completed home
• Mortgage: Secured by the property being purchased

Approval process:

• Construction loan: Stricter credit, income, and project documentation requirements
• Mortgage: Standard credit and income requirements

Interest rate:

• Construction loan: Usually higher and variable
• Mortgage: Typically lower, and many homebuyers choose a fixed-rate loan 

Do you need both a construction loan and a mortgage?

If you want to build a house the answer is probably yes — especially if you’re using a standalone construction loan. This type of loan covers the building phase only. Once the project is finished, you’ll need to secure a separate mortgage (often called a "take-out loan") to pay off the construction loan.

This two-step approach offers more flexibility. You can shop for the best mortgage terms once the home is built, and you aren’t locked into a permanent loan before knowing the final value of the finished property. But it does come with extra closing costs and paperwork. Alternatively, you can explore getting a construction-to-permanent loan. 

How construction-to-permanent loans work

Also called a one-time-close loan, this type of financing combines both the construction loan and the long-term mortgage into a single package.

Here’s how it works:

• You apply once and get approved for the total amount needed
• The loan funds are drawn in phases during construction
• When construction is complete, the loan converts into a permanent mortgage

The main advantage is convenience. You avoid applying twice, and you only pay closing costs once. This can save time, money, and stress compared to arranging a separate construction loan and mortgage.

Who should get a construction loan?

A construction loan is the right choice if:

• You’re building a custom home from the ground up
• You’re tearing down and rebuilding a property
• You’re working with a builder that doesn’t offer built-in financing
• You want to stay involved in the construction process

You’ll need to provide detailed plans, timelines, and budgets for the project. Lenders also typically require inspections at each draw stage and may ask for a larger down payment (often 20% to 25%).

Who should get a mortgage?

A traditional mortgage is the right choice if:

• You’re buying a move-in-ready home 
• You’re purchasing a newly built home from a builder offering turnkey financing
• You want a lower interest rate and simpler approval process
• You need predictable monthly payments over a longer period (in this case, make sure you get a fixed-rate mortgage)

Conventional, FHA, VA, and USDA loans all fall under the umbrella of standard mortgages. You can choose from fixed or adjustable rates and a range of loan terms to fit your budget.

Pros and cons of each financing type

Construction loan pros:

• Lets you finance custom builds or major renovations
• Interest-only payments during construction
• Flexibility to work with your own builder and design

Construction loan cons:

• Higher interest rates and closing costs
• Requires detailed documentation and project management
• Must convert to a mortgage later (unless using one-time-close)

Mortgage pros:

• Lower rates and simpler approval
• Available for a wide range of property types
• Easier budgeting with fixed monthly payments (if you get a fixed-rate loan)

Mortgage cons:

• Can’t be used for unbuilt homes
• No staged funding for construction projects
• Requires completed home at closing

How to choose the right loan for your situation

When deciding between a construction loan vs. mortgage, consider your project type, timeline, and financial goals. Ask yourself:

• Is the home already built or still in the design phase?
• Do I want one closing or can I manage two?
• Can I handle the complexity of a construction loan process?
• What kind of interest rate and repayment timeline makes sense for me?

Talking with a lender that offers both loan types can help you explore your options and figure out which approach fits your situation best.

Pro tip: Look for experienced lenders

Some lenders specialize in construction loans and may offer better draw schedules, inspection processes, or construction-to-permanent options. Others may steer you toward a standard mortgage or a builder-financed home. Make sure you shop around and compare carefully.

Understand your options before you build or buy

Choosing the right loan is one of the most important steps in your homeownership journey. Whether you’re breaking ground on your dream home or purchasing a move-in-ready property, understanding the difference between a construction loan vs. mortgage will help you make a smarter financing decision.

Ready to compare construction and mortgage rates side by side? Use our mortgage rate table to find competitive offers and see which loan structure fits your plans — and your budget.