Construction Loan
A construction loan funds ground-up development or major rehabilitation, disbursed in draws as work is completed rather than as a lump sum. Loans are sized by loan-to-cost (typically 75–85% maximum) and projected as-stabilized value, with interest paid only on funds drawn. Most convert to or are replaced by permanent financing at completion.
Lenders control risk through the draw process: inspections verify completed work before each disbursement, and a contingency reserve (typically 5–10% of hard costs) absorbs overruns.
Construction lenders typically require recourse — personal guarantees including completion guarantees — because an unfinished building is poor collateral.
On a $10 million development budget at 80% loan-to-cost, the sponsor typically funds the first $2 million of costs; the lender then advances the remaining $8 million in draws against inspected work, holding retainage back until completion.
Frequently asked questions
How does a construction loan draw schedule work?
Funds are released in stages rather than at closing. The contractor bills for completed work, the lender's inspector verifies it on site, and the draw funds less retainage — commonly 5–10% held back until the project finishes. Interest accrues only on what has actually been drawn, so early draws cost far less than the full commitment.
What is an interest reserve on a construction loan?
An interest reserve is loan proceeds set aside at closing to pay the loan's own interest while the building produces no income. Lenders size it from the projected draw schedule, rate and construction timeline. If the build runs long or a floating rate moves above the modelled level, the reserve can run out before completion and the sponsor funds interest directly.
Is a construction loan sized on loan-to-cost or loan-to-value?
Typically both, with the lender taking the lesser result. Loan-to-cost caps the loan against the development budget, commonly 75–85%. A second test caps it against projected as-stabilized value — Relendi's underwriting benchmarks cap construction LTV at 65% and set minimum coverage at 1.10x, measured on the income the finished building is projected to produce.
What does a sources and uses statement show on a construction loan?
Uses list every dollar the project spends — land, hard costs, soft costs, contingency, financing fees and the interest reserve. Sources show what funds them, typically sponsor equity plus the loan. Most construction lenders require the equity to go in first, so the loan starts drawing only once the sponsor's contribution is fully in the ground.