Understanding Construction Loan Interest
Construction loans are different from standard mortgages. Instead of receiving the full amount at once, the lender releases money in stages as the project moves forward. These stages are called draws. You only pay interest on the portion that has been drawn, not on the full loan.
Because of this, your interest bill changes month to month depending on how much has been used. This makes calculating construction loan interest a little tricky but with the right formula, it’s simple.
Basic Formula for Monthly Interest
The formula is straightforward:
Monthly Interest = Drawn Amount × (Annual Interest Rate ÷ 12)
Example:
If $50,000 is drawn with an 8% annual rate:
$50,000 × (0.08 ÷ 12) = $333.33 in monthly interest.
How to Track Interest with Multiple Draws
- Note the amount released each month.
- Add it to the outstanding balance.
- Apply the monthly interest formula.
- Repeat for each month and total the amounts.
Example:
- Month 1: Draw $40,000 → Interest = $266.67
- Month 2: Add $30,000 → Balance $70,000 → Interest = $466.67
- Month 3: Balance unchanged → Interest = $466.67
Total interest for 3 months = $1,200.
Quick Rule of Thumb for Total Interest
Since builders usually release funds evenly, lenders often use a shortcut:
Estimated Interest = (Loan Amount × Annual Rate × Build Months ÷ 12) ÷ 2
This assumes, on average, half the loan is outstanding over the build.
Example: $300,000 loan, 6% rate, 9-month project → $6,750 total estimated interest.
Planning Your Interest Reserve
Many lenders require setting aside an “interest reserve” — a budget that covers the expected interest during construction. This ensures you can pay monthly bills without slowing the project.
If you don’t want to calculate every draw manually, you can use a construction loan calculator that automatically figures out monthly and total interest based on your draw schedule. This helps you see the real numbers before signing the loan.
You can try a calculator that handles these step-by-step estimates at GoodTools’ construction loan calculator.
When the Loan Converts to a Mortgage
Once the home is finished, the construction loan typically converts into a permanent mortgage. At that stage, payments shift from interest-only to principal + interest. The final loan balance will include everything drawn, plus any interest that was rolled into the loan.
If you want to check how much you could actually afford once the loan turns into a regular mortgage, it’s worth using an affordability calculator to compare monthly payments with your budget.
A clear guide is available here: How Much Construction Loan Can I Afford Calculator on GoodTools.
Practical Tips for Smooth Planning
- Always confirm if your rate is fixed or variable.
- Request a clear draw schedule from your lender.
- Keep a buffer for delays — longer projects mean more interest.
- Check if your loan allows “capitalized interest” (adding interest into the loan instead of paying monthly).
- Use a calculator to double-check totals instead of guessing.
For exact projections, tools like the GoodTools Construction Loan Calculator make it much easier than manual math.
Final Quick Answer
Monthly construction loan interest = Drawn amount × (annual rate ÷ 12).
Add each month’s figure to find the total, or let a calculator do it for you.