How Construction Financing Works

Construction financing is fundamentally different from traditional mortgage financing. Instead of receiving the full loan amount at closing, the loan is disbursed in stages (draws) as construction progresses. This structure protects the lender and ensures the funds are used for the project. Understanding how construction loans work is essential before starting any construction or development project.

How Construction Loans Work

A construction loan is a short-term loan (typically 12–24 months) used to finance the construction of a building or development project. The loan is disbursed in draws — periodic releases of funds — as construction milestones are reached. During the construction period, the borrower typically pays interest only on the drawn amount. When construction is complete, the loan is either paid off (with permanent financing) or converted to a permanent mortgage.

Key Metrics: LTC and LTV

Construction lenders evaluate two key metrics:

• LTC (Loan-to-Cost): The loan amount as a percentage of the total project cost (land + construction + soft costs). Most construction lenders offer 75–90% LTC, meaning the borrower needs 10–25% of the project cost in equity.
• LTV (Loan-to-Value): The loan amount as a percentage of the completed project's appraised value (as-completed value or ARV). Most construction lenders cap LTV at 70–75%.

Read our construction loan LTC & LTV guide for more detail.

The Draw Schedule

Funds are released according to a draw schedule, which is tied to construction milestones:

• Foundation / site work
• Framing
• Enclosure (roof, windows, doors)
• Interior finishes
• Final completion

Before each draw is released, the lender typically requires an inspection to verify the work has been completed. This protects the lender and ensures funds are used appropriately.

What Construction Lenders Evaluate

• Borrower experience: Lenders want to see that the borrower (or the general contractor) has relevant construction experience.
• Project plans and budget: Detailed construction plans, specifications, and a line-item budget.
• Contractor qualifications: The general contractor's experience, licensing, and insurance.
• Appraisal: An as-completed appraisal showing the projected value of the finished project.
• Borrower financials: Credit, income, and liquidity to cover the equity injection and interest payments during construction.
• Exit strategy: How the construction loan will be paid off — typically through sale, refinance, or conversion to permanent financing.

Types of Construction Financing

• Construction-to-permanent: A single loan that converts to a permanent mortgage when construction is complete. Learn more.
• Construction-only: A short-term loan that must be paid off (typically refinanced) when construction is complete.
• Private construction loans: Financing from private lenders rather than banks. Often faster but with higher rates.

What to Prepare

• Detailed construction plans and specifications
• Line-item construction budget
• Contractor information and qualifications
• Property information (if you already own the land) or land purchase details
• Personal/business financial statements
• Exit strategy (sale, refinance, or hold)

Next Step

If you're planning a construction project, submit your information for a review, or explore our construction loans page.