HOW CONSTRUCTION LOANS WORK
Milestone-Based Funding for Your Build
Unlike permanent loans that fund in a lump sum, construction loans release capital through a draw schedule tied to project milestones. You request a draw after completing each phase (foundation, framing, mechanical, finish), an inspector verifies the work, and the lender releases the budgeted amount. Interest accrues only on drawn funds, and an interest reserve is typically built into the loan to cover payments during construction.
Ground-Up Construction
New building from vacant land. Full draw schedule from site prep through certificate of occupancy. Requires architectural plans, contractor bids, and takeout commitment.
Major Renovation
Substantial rehab of existing structures. Partial draw schedule for demo, structural, mechanical, and finish work. Existing structure reduces lender risk vs. ground-up.
Construction-to-Permanent
Single close that converts automatically from construction draws to permanent amortizing debt at completion. Saves on double closing costs and eliminates takeout risk.
Interest Reserve
Lender capitalizes 12–24 months of estimated interest payments into the loan amount. You don’t make monthly payments out of pocket during construction.
Contingency Requirement
Lenders require 5–15% hard cost contingency in the construction budget. This protects against change orders, material cost increases, and unforeseen conditions.
Takeout Commitment
Most construction lenders require evidence of permanent financing commitment before funding. Planning your takeout early is essential. See our Permanent Financing guide.
WORKED EXAMPLE
Example: Sources and Uses for a $5,000,000 Build
Construction lenders size the loan on loan-to-cost: a percentage of the whole budget, not only the building. Every cost goes in the “uses” column, and the loan and your equity must add up to it. Here is one project run through our LTC calculator, with assumptions for illustration only.
| Uses (the budget) | Amount |
|---|---|
| Land (or its purchase price) | $800,000 |
| Hard costs — site work, building, general contractor | $3,200,000 |
| Hard-cost contingency (5%) | $160,000 |
| Soft costs — design, engineering, permits, impact fees, legal, insurance, loan fees | $620,000 |
| Interest reserve (estimated interest during construction) | $220,000 |
| Total project cost | $5,000,000 |
| Sources (who pays for it) | Amount |
|---|---|
| Construction loan at 75% LTC | $3,750,000 |
| Your equity (25%) | $1,250,000 |
Lenders usually want the equity in first: the loan funds only after your cash has paid its share of the budget. Land you already own often counts toward equity, generally at its cost or appraised value — each lender sets the rule. If you buy the site before construction financing is ready, a land loan can carry it in the meantime, typically lending 50–70% of its value. At the 65–80% LTC most lenders offer, equity runs 20–35% of total cost.
Typical ranges, updated September 2026. Your terms depend on the property, the borrower and the lender.
TIMELINE
Construction Loan Timeline: Application to Permanent Loan
- Application and approval — plans, budget, contractor, appraisal (“as-complete” value) and environmental review. Plan on 45–90 days to close.
- Closing and equity in — your equity funds the first costs; the loan starts after.
- Draws during construction — usually monthly, each after an inspector confirms the work. Interest is charged only on what has been drawn, often paid from the interest reserve.
- Completion and certificate of occupancy — the city signs off; the lender may hold back a small amount for punch-list items.
- Lease-up — the property fills to stabilized occupancy (85–90%+).
- Permanent loan or sale — the construction loan, a 12–24 mo loan, is repaid by permanent financing sized on actual NOI, or by selling the property.
WHAT LENDERS REQUIRE
Hard Costs, Soft Costs and the Guarantees Lenders Ask For
Hard costs are the physical build: site work, foundations, structure, mechanical systems, finishes and the general contractor’s fee. Soft costs are everything else needed to finish: design and engineering, permits and impact fees, legal, insurance, loan fees and the interest reserve. Lenders review both line by line and want a contingency on hard costs.
Guarantees. Most construction loans have personal guarantees from the sponsors, often more than one kind:
- Completion guarantee — you promise to finish the project and pay any cost overruns.
- Repayment guarantee — you are personally liable for all or part of the loan.
- Carry guarantee — you cover interest, taxes and insurance until the property can pay them.
What lenders check in the sponsor: experience completing similar projects, liquidity and net worth relative to the loan, credit, a general contractor with a fixed-price or guaranteed-maximum-price contract, and a credible exit — pre-leasing or a sale plan.
CONSTRUCTION LOAN OPTIONS
Compare Construction Financing by Lender Type
| Bank / Portfolio | SBA 504 | Private / Bridge | |
|---|---|---|---|
| Rate | 6.75–8% | 6.25–7.25% blended | 9–13% |
| Max LTC | 70 – 80% | Up to 90% | 65 – 75% |
| Term | 12 – 24 months | Construction + 25yr perm | 12 – 18 months |
| Occupancy | None required | 60%+ owner-occupied from the start | None required |
| Speed | 45 – 90 days | 60–90 days to close the interim loan | 14 – 30 days |
| Best For | Experienced developers | Owner-occupants, 10–20% down | Speed, non-bankable |
Estimate your construction budget: LTC Calculator · Payment Calculator
Typical ranges, updated September 2026. Your terms depend on the property, the borrower and the lender.
Free tools
Run the numbers
The same metrics a lender checks — free, instant, no signup. Each result links straight into an application.
- LTC Calculator Loan-to-cost (LTC) is the loan divided by the total project cost — land, hard costs and soft costs. Enter your budget to see your LTC, the most a lender's LTC limit allows you to borrow, and the equity you need to bring.
- Commercial Mortgage Calculator Estimate your monthly CRE loan payment, total interest cost, and full amortization schedule. Compare loan structures before you apply.
FREQUENTLY ASKED QUESTIONS
Construction Loan FAQ
How much down payment do you need for a commercial construction loan?
Construction loans are sized on total project cost, so the “down payment” is your equity share of the whole budget — land, hard costs, soft costs and interest. At 65–80% LTC, that is 20–35%; on a $5,000,000 project at 75% LTC, $1,250,000. SBA 504 lets an owner-occupant build with 10–20% down. Land you already own often counts toward equity.
Is it hard to get a commercial construction loan?
Harder than a purchase loan, because the lender is financing a building that does not exist yet. Approval turns on the sponsor’s track record with similar projects, liquidity after the equity goes in, a complete budget with contingency, a qualified general contractor and a believable exit — pre-leasing, a sale plan or a permanent lender’s interest. First-time developers often partner with an experienced one or start with a smaller project.
How does the draw process work?
You submit a draw request with invoices and completion evidence. The lender sends an inspector to verify the work matches the approved budget and schedule. Once verified, funds are released (typically within 5–10 business days). Most loans have 4–8 draws over the construction period, each tied to specific milestones.
Do I need a permanent financing commitment before I can get a construction loan?
Most bank lenders require a takeout commitment or letter of intent from a permanent lender before funding construction. Construction-to-permanent loans eliminate this requirement since the same loan converts automatically. SBA 504 construction includes permanent financing by design.
What documents do I need for a construction loan application?
Architectural plans, detailed construction budget with line items, general contractor bid and qualifications, project timeline, environmental (Phase I), survey, zoning confirmation, personal financial statements, and entity documents. The more complete your package, the faster the approval.
What happens if construction costs exceed the budget?
The contingency reserve (5–15% of hard costs) covers overruns up to a point. Beyond that, you’ll need additional equity. Some lenders allow budget reallocation between line items with approval. Significant overruns may require a loan modification or supplemental financing.
Can I use SBA 504 for ground-up construction?
Yes. SBA 504 can fund owner-occupied construction with 10% down — 15% for a business two years old or less or a special-purpose building, 20% if both apply. An interim construction loan funds the build; after completion the CDC/SBA portion (up to 40%) replaces part of it with a fixed rate for up to 25 years, next to the bank first mortgage (50%). Your business must occupy at least 60% of the new building from the start.
How long does construction loan approval take?
Bank: 45–90 days. SBA 504: about 60–90 days to approval and the interim construction loan closing; the SBA debenture then funds after the building is finished. Private/bridge: 14–30 days. The construction underwriting process is longer than acquisition loans because lenders must evaluate the plans, budget, contractor, and timeline in addition to standard borrower and property analysis.
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