A construction loan does not hand you the money. It reimburses you — in stages, after inspection, less a holdback — for work already in the ground. Borrowers who expect a funded account on day one run out of cash in month two; borrowers who understand the draw cycle finance the build smoothly on the lender’s money. This page covers building construction only: ground-up builds and major rehabs of a structure. Financing the equipment that works on a site is a different product in a different cluster; here, everything is the building.
General information, not financial advice.
The mechanic to internalize: the contractor completes the work first, then the loan pays for it. Each draw cycle runs the same sequence (getbuilt / yieldstack / bridge.co consensus):
Lenders withhold 5–10% of each draw as retainage until substantial completion (bridge.co’s draw-schedule guidance, citing FDIC construction-lending examination procedures; yieldstack cites the OCC’s holdback controls). Retainage is the lender’s lever to guarantee the last 5% of the work — punch lists, final finishes, systems commissioning — actually gets finished. It is released at the end, gated on the final inspection, collected lien waivers from every tier, and the certificate of occupancy. Builders price retainage into their own subcontractor terms; owners should price it into their cash plan, because a project that is 95% funded at 90% completion has a gap that comes from somewhere, and that somewhere is usually the owner’s pocket at the worst moment of the build.
Interest accrues only on the drawn balance, never on the commitment. That single fact is why the draw structure exists:
Illustration (rate illustrative): a $2,000,000 commitment drawn evenly over 12 months carries an average drawn balance of ≈$1,000,000. A year of construction interest at an illustrative 9% is therefore ≈$90,000 — versus $180,000 if the full commitment had been funded on day one.
And since a building under construction earns nothing, most construction loans include an interest reserve: a budget line inside the loan from which the loan’s own interest is paid during the build. The reserve is sized against the projected draw curve, which is one more reason lenders care that your draw schedule is realistic — an overrun that exhausts the reserve converts interest into a cash call.
Construction lenders take the lesser of two ceilings: loan-to-cost (LTC) against the total project budget, and as-completed loan-to-value against the appraised finished property — backstopped by a stabilized DSCR or debt-yield test against the permanent phase. LTC bands from lender guides (thornecre / lendingstreet / relendi): banks ~65–75% LTC; private debt funds reach ~75–85%. Contingency reserves of 5–10% of hard costs are budgeted inside the deal — lenders expect overruns and underwrite them in advance. Terms run ~12–36 months, floating (commonly SOFR plus a spread, quoted at ~300–750bp in lender guides — a guide band, not a quote). The land the building sits on is often draw number one or a prior acquisition: commercial land loans cover that leg.
A construction loan is a bridge to one of two exits. The classic route is a take-out refinance into a permanent loan once the property is built and leased — functionally a refinance decision, evaluated like one (commercial real estate refinance), sometimes with a mini-perm — a short permanent loan — in between while occupancy stabilizes. The alternative is single-close construction-to-permanent, where one loan converts at completion; conversion is conditional on the finished property hitting the underwritten DSCR and occupancy, so the conditions are part of the original bargain, not a formality. Owner-occupied projects have an additional route: SBA 504 and 7(a) both finance construction, introduced in buying commercial property for your business. Construction-period costs beyond interest — inspections, title updates, draw fees — are catalogued in commercial real estate closing costs.
The practical thread running through all of it: a construction loan rewards the borrower who treats documentation as part of the build. Draw packages assembled the week work completes — waivers collected as subcontractors are paid, percent-complete reconciled with the inspector before the visit — keep the cycle inside the month. Draw packages assembled in a scramble at month-end push funding into the next one, and the contractor’s schedule, not the lender’s, absorbs the delay.
How do construction loan draws work? In arrears: the contractor completes work, submits a pay application (AIA G702/G703) with invoices and lien waivers, an inspector verifies percent-complete, the lender runs its in-balance and title checks, and funds release less retainage. Each cycle funds verified, completed work only.
How much retainage do lenders hold back, and when is it released? Typically 5–10% of each draw, held until substantial completion. Release is gated on the final inspection, collected lien waivers from all tiers, and the certificate of occupancy.
Do you pay interest on the full loan amount during construction? No — only on the drawn balance. A $2M commitment drawn evenly over a year carries an average balance near $1M, so a year of interest at an illustrative 9% runs about $90,000 rather than $180,000. An interest reserve inside the loan usually pays that interest during the build.
How does the interest reserve work as draws increase? It is a budget line inside the loan earmarked for interest payments while the property produces no income. As draws rise, the drawn balance — and therefore the interest — rises with them, and the reserve is depleted on the projected curve. If the build overruns and the reserve empties early, interest becomes an out-of-pocket cost.
Sources: bridge.co construction draw-schedule guide (citing FDIC examination procedures) and FAQ sections; getbuilt and yieldstack draw-process guides (citing OCC holdback controls); relendi, thornecre and lendingstreet lender guides (interest reserve, LTC bands, contingency). Illustration computed for this page; rate labelled illustrative. Currency verified 2026-10-23.