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Recently I heard from a reader who had just finished building a new home. He noticed something on his loan paperwork that didn’t sit well: his construction loan rate floated two percent above prime. This was on top of a one percent origination fee and several smaller charges. He questioned why the bank would need another two percent. Wasn’t it already essentially lending out ten times the money it held, earning easy profits at everyone else’s expense?
His suspicious reaction is understandable. Building a home is a stressful project. Every decision feels consequential, and costs seem to shift overnight. Under that kind of strain, seeing yet another fee can activate a suspicious part that whispers, “You’re being taken advantage of.”
Yet in most cases, construction loan pricing isn’t a sign of greediness. It reflects the fact that a construction loan is both riskier and far more labor-intensive than a conventional mortgage.
A standard mortgage is secured by a finished home with a clear market value. A construction loan is secured by a plan and a hole in the ground. Weather delays, contractor problems, supply shortages, and cost overruns can derail a build. If something goes wrong, the bank may end up with a partially finished structure that’s difficult to sell and expensive to complete.
Because of this, construction loans require continuous oversight. Borrowers don’t receive all the funds at once. Money is released in stages, and each draw requires inspections, documentation, lien waivers, and staff time. The origination fee compensates for the upfront work. The extra spread above prime compensates for everything that follows.
The belief that banks lend out ten dollars for every dollar they hold is also a common misunderstanding. It traces back to the old “fractional reserve” model, which hasn’t shaped bank lending for years. According to the Federal Reserve, reserve requirements were reduced to zero during the pandemic and have remained there.
