Construction financing differs fundamentally from a purchase financing: the asset does not exist yet. Funders manage that gap by releasing money in stages, tied to verified progress on the project.
Structures range from small commercial renovations to ground-up construction of retail, industrial, office, or multifamily buildings.
How it generally works
The funder approves a total project budget and releases funds in draws as milestones complete : typically after inspections verify progress. Interest generally accrues only on drawn amounts during construction.
At completion, the structure either converts to permanent financing or is repaid through a separate permanent financing closing, depending on the arrangement.
What a project budget typically includes
- Land or property acquisition
- Hard costs : materials and labor
- Soft costs : design, engineering, permits, fees
- Contingency reserves
- Carrying costs during construction
What funders commonly evaluate
- The borrower's or developer's experience with similar projects
- Contractor qualifications and track record
- Completed plans, specs, budget and timeline
- The completed project's value and, for income property, projected income
- Borrower equity contribution to the project
Potential advantages and trade-offs
Advantages: funding matched to actual construction progress, cost only on drawn amounts during the build, and the ability to create exactly the asset you need.
Trade-offs: budget overruns, delays and contractor issues are common risks; draw inspections add process; and permanent financing still needs to be arranged unless the structure includes conversion.
How repayment is typically structured
During construction, periodic cost payments on drawn amounts. At completion, either conversion to a permanent structure or payoff through separate permanent financing or a sale. Understand the take-out plan before breaking ground.