How is a construction loan calculated?
A construction loan works differently from a standard mortgage. Instead of receiving the full loan amount upfront, the lender disburses funds in stages called draws. Each draw is released when a construction milestone is verified by the lender's appraiser or inspector. You pay interest only on the amount that has been drawn so far, not on the full loan commitment.
During the construction phase, your payments are interest-only. The formula is straightforward: monthly interest = outstanding drawn balance x (annual rate / 12). Because your drawn balance increases with each stage, your monthly interest payment steps up throughout the build. Early in construction, when only the foundation draw has been released, your payments are relatively low. By the final draw, you are paying interest on the full loan amount.
After construction is complete, the loan converts to a standard residential mortgage (called a take-out mortgage). At this point, Canadian mortgage rules apply: semi-annual compounding under the Interest Act, standard amortization periods of 25 to 30 years, and lower residential mortgage rates. The effective monthly rate for the take-out mortgage is calculated as (1 + annual rate / 2)^(1/6) - 1.
The total cost of a construction project includes the down payment, all interest paid during the build phase, and the total mortgage payments over the amortization period. The construction loan calculator above computes all of these for you.
How do construction loan draws work?
Construction loan draws are the mechanism by which the lender releases funds during your build. Rather than giving you the entire loan at once, the lender holds back funds and releases them as construction milestones are completed and verified. This protects both the lender and the borrower.
A typical 4-draw schedule follows these milestones: foundation completion, framing completion, lock-up (roof, windows, and doors installed), and final completion. A 5-draw schedule adds a drywall stage between lock-up and completion. A 6-draw schedule further adds a finishing stage for cabinetry, flooring, and fixtures.
Before each draw is released, the lender sends an appraiser or inspector to verify that the work has been completed to the required standard. This inspection typically costs $150 to $300 per visit and is charged to the borrower. The draw is released within a few business days of a successful inspection.
The amount of each draw is typically equal, but some lenders front-load draws to help with early construction costs. For a $440,000 loan with 4 draws, each draw would be approximately $110,000. After the first draw, you pay interest on $110,000. After the second draw, you pay interest on $220,000, and so on.
| Draw stage | Construction milestone | Typical completion |
|---|---|---|
| Draw 1 | Foundation complete | Month 1-2 |
| Draw 2 | Framing complete | Month 3-4 |
| Draw 3 | Lock-up (roof, windows, doors) | Month 5-7 |
| Draw 4 | Drywall and mechanical | Month 7-9 |
| Draw 5 | Finishing (cabinets, flooring) | Month 9-11 |
| Draw 6 | Final completion and occupancy | Month 11-12 |
How is a construction loan different from a regular mortgage?
Construction loans and regular mortgages are fundamentally different products. A regular mortgage finances an existing property that has already been appraised and can be occupied immediately. A construction loan finances a building project where the final property does not yet exist. This difference drives every aspect of how the loan is structured.
Payment structure is the clearest difference. A regular mortgage requires principal-and-interest payments from day one. A construction loan charges interest-only payments during the build phase, and only on the amount drawn. This keeps monthly costs lower during construction when you may also be paying rent or a mortgage on your current home.
Interest rates on construction loans are typically 1% to 2% higher than residential mortgage rates. As of early 2026, construction loan rates range from 6% to 9%, compared to 4% to 6% for residential mortgages. The higher rate reflects the added risk: the property does not exist yet, construction can encounter delays, and the final value depends on the quality of the build.
Down payment requirements are more demanding. Most lenders require 20% to 35% of the total project cost (land plus construction) as a down payment. CMHC insurance is not available for construction loans in most cases, so the lender bears the full default risk.
| Feature | Regular mortgage | Construction loan |
|---|---|---|
| Payment type | Principal + interest | Interest-only during build |
| Funds disbursement | Full amount at closing | Progressive draws |
| Typical rate (2026) | 4.5% - 6.0% | 6.0% - 9.0% |
| Minimum down payment | 5% (insured) | 20% - 35% |
| CMHC insurance | Available | Generally not available |
| Loan term | 25-30 year amortization | 6-24 month build + conversion |
| Inspections | One appraisal | Multiple draw inspections |
Worked example: building a $550,000 home
Consider a couple building a custom home outside Toronto. The lot costs $150,000 and the construction budget is $400,000, for a total project cost of $550,000. They put 20% down: $550,000 x 20% = $110,000. The construction loan amount is $440,000.
They secure a construction loan at 7.0% with a 12-month build period and 4 equal draws. Each draw is $440,000 / 4 = $110,000. The monthly interest rate is 7.0% / 12 = 0.5833%.
After draw 1 (month 1): interest-only payment = $110,000 x 0.5833% = $642/month. After draw 2 (month 4): payment rises to $220,000 x 0.5833% = $1,283/month. After draw 3 (month 7): payment = $330,000 x 0.5833% = $1,925/month. After draw 4 (month 10): payment = $440,000 x 0.5833% = $2,567/month.
Total construction interest over 12 months: approximately $18,550. This is money paid for interest only and does not reduce the loan principal.
After construction, the $440,000 loan converts to a standard mortgage at 5.0% over 25 years. Using semi-annual compounding, the effective monthly rate is 0.4124%. The monthly mortgage payment is approximately $2,563. Over 25 years, total mortgage payments are approximately $768,900.
Total project cost: $110,000 (down payment) + $18,550 (construction interest) + $768,900 (mortgage payments) = $897,450. The construction interest represents about 2% of the total cost but is an important planning consideration because it is paid during the build when cash flow may be tight.
Qualifying for a construction loan in Canada
Construction loan qualification is more involved than a standard mortgage approval. Lenders evaluate not just your financial profile but also the viability of the construction project itself. Here is what lenders typically require.
- ✓A minimum down payment of 20% to 35% of the total project cost (land value plus construction budget). Some lenders require 25% or more for custom builds without a fixed-price contract.
- ✓A signed fixed-price or cost-plus contract with a licensed general contractor. Most lenders will not finance owner-builder projects due to the higher risk of cost overruns and construction quality issues.
- ✓Detailed construction plans including architectural drawings, engineering specifications, and a complete materials list. The lender's appraiser uses these to estimate the completed property value.
- ✓An appraisal of the completed property (as-if-complete appraisal). The lender needs to confirm that the finished home will be worth at least the total project cost. This protects the lender in case of default.
- ✓Proof of building permits from the local municipality. Construction cannot begin without permits, and draws will not be released until the project is properly permitted.
- ✓Standard income and credit documentation including employment letters, tax returns, and credit bureau reports. Most lenders require a minimum credit score of 680 for construction financing.
- ✓Evidence of a holdback arrangement. Ontario's Construction Act requires a 10% holdback on each draw for 60 days to protect against builder's liens. Other provinces have similar requirements.
How to reduce costs on a construction loan
Construction loans are more expensive than regular mortgages, but several strategies can reduce your total cost significantly.
- ✓Maximize your down payment. Putting down 25% or more reduces your loan amount and may qualify you for a better rate. Every $10,000 less borrowed saves approximately $700 in construction interest on a 12-month build at 7%.
- ✓Shorten the build timeline. Construction interest accrues every month. Completing a build in 10 months instead of 14 months can save thousands in interest. Work with your contractor to create a realistic but aggressive schedule.
- ✓Negotiate fewer draws. Fewer draws mean fewer inspection fees ($150-$300 each). If your lender allows 4 draws instead of 6, you save $300 to $600 in inspection costs alone.
- ✓Shop construction loan rates from at least three lenders. Credit unions often offer construction financing at rates 0.5% to 1.0% lower than major banks. Mortgage brokers who specialize in construction can also source competitive rates.
- ✓Lock in your take-out mortgage rate during construction. Some lenders offer rate holds of 120 to 180 days. If rates rise during your build, a rate hold protects your post-construction mortgage payment.
- ✓Use a single-close construction-to-permanent loan if available. This combines the construction loan and the take-out mortgage into one product, saving you a second set of closing costs (typically $2,000 to $5,000).
- ✓Budget a contingency of 10% to 15% above your construction estimate. Unexpected costs are common in construction. A contingency fund prevents you from needing additional financing at unfavourable terms.
Frequently asked questions
What is a construction loan in Canada?
A construction loan is a short-term loan that finances the building of a new home. Unlike a regular mortgage, funds are released in stages (draws) as construction milestones are completed. You pay interest only on the amount drawn during the build phase. Once construction is complete, the loan converts to a standard residential mortgage with regular principal-and-interest payments.
How much do you need to put down on a construction loan?
Most Canadian lenders require 20% to 35% of the total project cost (land plus construction budget) as a down payment. The exact requirement depends on the lender, the project type, and whether you have a fixed-price contract with a licensed builder. Custom builds and owner-builder projects typically require higher down payments, often 25% to 35%.
What is the interest rate on a construction loan in Canada?
Construction loan rates in Canada currently range from 6% to 9%, depending on the lender, your credit profile, and the project details. These rates are 1% to 2% higher than standard residential mortgage rates. After construction is complete and the loan converts to a regular mortgage, you benefit from lower residential rates, typically 4% to 6%.
Do you pay interest during construction?
Yes. During the construction phase, you make interest-only payments on the amount that has been drawn (disbursed) so far. You do not pay interest on the full loan commitment until all draws have been released. This means your monthly payment increases with each draw as the outstanding balance grows.
How many draws are in a construction loan?
Construction loans typically have 4 to 6 draws, aligned with construction milestones. A 4-draw schedule covers foundation, framing, lock-up, and completion. A 5 or 6-draw schedule adds intermediate stages like drywall and finishing. Before each draw, a lender-appointed inspector verifies that the milestone has been met.
Can you build a house with 20% down in Canada?
Yes. Many lenders accept 20% down on the total project cost for construction loans, provided you have a signed fixed-price contract with a licensed general contractor and a strong credit profile. However, some lenders and some project types (custom builds, rural properties) may require 25% to 35% down.
What is a take-out mortgage?
A take-out mortgage is the standard residential mortgage that replaces the construction loan after the build is complete. The construction loan is paid off, and a new mortgage is set up with a longer amortization period (typically 25 years) and a lower interest rate. Some lenders offer construction-to-permanent loans that convert automatically without a second closing.
Can you get CMHC insurance on a construction loan?
CMHC insurance is generally not available for construction loans during the build phase. However, once construction is complete and the property is appraised, the take-out mortgage may qualify for CMHC insurance if the down payment is at least 5% and the property meets CMHC guidelines. This can help you access lower rates on the post-construction mortgage.
What is the difference between a construction loan and a draw mortgage?
These terms refer to the same product. A draw mortgage is simply the common Canadian term for a construction loan, emphasizing the progressive draw (disbursement) structure. Both refer to a loan that releases funds in stages as construction milestones are verified by an inspector.
How long is a construction loan term?
Most construction loan terms are 6 to 24 months, matching the expected build timeline. If construction takes longer than expected, you may need to request an extension, which often comes with a fee and potentially a higher rate. After construction is complete, the loan converts to a standard mortgage with a 25 or 30-year amortization.