From land acquisition through vertical construction to certificate of occupancy — how private construction loans work, how draws are processed, and what lenders require.
Ground-up construction loans are fundamentally different from fix-and-flip loans. While a rehab loan finances the improvement of an existing structure, a construction loan finances the creation of something new — from a raw lot through foundation, framing, rough-in systems, and finishes to a finished, marketable property. This creates a distinct risk profile for lenders, which is why construction loans typically require more documentation, more borrower experience, and more robust project oversight than other private lending products.
The key financial metric in construction lending is loan-to-cost (LTC), not loan-to-value (LTV). LTC measures the loan amount as a percentage of the total project cost — land plus hard construction costs plus soft costs like permits, architecture, and engineering. A lender offering 85% LTC on a $800,000 total project cost will fund $680,000. The borrower brings the remaining $120,000 in equity. LTC is preferred over LTV for construction lending because there is no existing structure to value; you're lending against a budget and a plan, not a building that exists today.
Construction loan draws work on a milestone basis rather than on time intervals. The borrower and lender agree at closing on a draw schedule tied to construction milestones — typically: land close, foundation complete, framing complete, roofing and exterior complete, rough-in mechanical/electrical/plumbing, insulation and drywall, finishes, and certificate of occupancy. After each milestone is complete, the borrower submits a draw request, an inspector verifies completion, and the lender funds the next draw directly to the builder or to the borrower to pay the builder. This draw-based structure ensures that lender funds are only disbursed for work already completed.
Builder experience is a critical underwriting factor in construction lending. Most private lenders require borrowers to demonstrate a track record of completed construction projects before they will fund a ground-up loan. At minimum, you'll typically need to show 1–3 completed projects of similar scope. If you're a first-time builder, some lenders will work with you if you have a highly experienced general contractor with a strong track record and if you're willing to provide additional equity. The lending relationship often mirrors a mentorship: a new builder with a strong GC and strong equity can access capital, but the bar is higher.
The cost breakdown for a construction loan includes the interest rate (typically 10%–13% for private construction financing), origination fees (1–3 points), draw inspection fees, and a contingency reserve that is often set aside in escrow to cover overruns. Interest on construction loans is charged on the outstanding drawn balance, not the full loan amount — so if you've drawn $300,000 of a $600,000 loan, you're paying interest only on $300,000. This interest reserve is often built into the loan itself, meaning the lender funds the interest payments from the construction budget rather than requiring the borrower to make cash payments during construction.