How to Calculate the True Cost of Your Construction Loan

When considering a construction loan, it’s essential to look beyond just the principal and interest rates. Understanding the true cost of your construction loan involves accounting for various fees, contingencies, and financial factors that could impact your overall budget. Here’s a comprehensive guide to calculating the true cost of your construction loan.

1. Loan Interest and Payment Structure
Most construction loans are interest-only during the construction phase, meaning you only pay interest on the funds that have been disbursed. However, once construction is complete, the loan typically converts into a standard mortgage with principal and interest payments.

• Interest Rates: Understand whether your loan has a fixed or variable interest rate.
• Loan Draw Schedule: Funds are released in stages based on construction progress, which impacts the interest calculations.

2. Origination Fees and Closing Costs
Lenders charge fees for processing and underwriting your construction loan. These costs vary by lender but generally include:

• Loan origination fees (usually 0.5% – 2% of the loan amount)
• Application fees
• Closing costs (title search, attorney fees, document preparation, etc.)
• Appraisal fees (to assess project value before approval)

3. Inspection and Draw Fees
Throughout construction, lenders require periodic inspections before releasing additional funds. These inspections help ensure that the project is progressing as planned.

• Expect to pay $100–$300 per inspection.
• Multiple inspections may be required, depending on the project timeline.

4. Contingency Reserves
Many lenders require borrowers to set aside a contingency reserve (typically 10–15% of the total project cost) to cover unexpected expenses, material cost increases, or design changes.

5. Interest Rate Adjustments
If you have a variable-rate loan, interest rates may change throughout the construction period, potentially increasing your overall borrowing costs.

6. Construction Delays and Penalties
Unexpected delays due to weather, labor shortages, or permit issues can extend the loan term, leading to higher interest payments and additional costs.

7. Conversion Fees (for Construction-to-Permanent Loans)
If your construction loan transitions into a permanent mortgage, some lenders charge a conversion fee. Verify these terms upfront.

8. How to Estimate Your Total Loan Cost

Use this simple formula:
Total Cost = (Loan Amount + Interest Payments + Fees + Contingency Reserves + Inspection Costs)

Being aware of these costs upfront can help you avoid financial surprises. Work with a knowledgeable lender and financial advisor to estimate all expenses accurately before starting your construction project.