Construction loan
A construction loan funds building work in stages rather than advancing the whole sum at closing.
Money is released as draws against verified progress, and interest accrues only on what has actually been drawn.
How the draw schedule works#
The loan is structured around milestones — foundation, framing, roof, mechanical rough-in, drywall, completion.
At each stage the borrower requests a draw, an inspection verifies the work, and funds are released.
Payments are interest-only on the drawn balance, which means they start small and rise through the project. A borrower carrying an existing mortgage while building is paying both, and the construction payment grows every month.
Two structures#
Construction-to-permanent. One loan, one closing. It funds the build and converts to a standard mortgage on completion. Fewer costs, and the permanent rate is generally locked at the outset.
Standalone construction. A short-term loan repaid by a separate mortgage on completion. Two closings, two sets of costs, and the permanent financing has to be obtainable at the end — which is a real risk if rates or circumstances move during the build.
Why lenders ask when work started#
The mechanic's lien priority question, and it is not a formality.
A mechanic's lien can take priority from the commencement of the improvement rather than from the date the lien statement was filed.
So a lender recording a mortgage after visible work has begun can find itself ranking behind a lien filed months later by a contractor who started before the loan closed.
Title companies ask about this, lenders require assurances about it, and it is why the sequence of starting work and closing financing matters.
Overruns#
The structural risk in construction lending.
A budget approved at the outset does not expand because the project did. Costs above the approved amount come from the borrower's own funds, and a project that runs over on a fixed loan stalls at whatever stage the money ran out.
An unfinished building is poor collateral and an unusable asset, which is why lenders underwrite the contingency as carefully as the budget.
For distressed property#
A construction loan is one route to funding a rehabilitation, alongside a 203(k) for owner-occupied purchases and hard money where speed or condition rules out conventional lending.
The choice turns on occupancy, timeline and the property's current state. A building failing minimum property standards cannot be financed conventionally at all, which is exactly the gap hard money fills — at a cost that belongs in the project arithmetic from the beginning.