How Construction Loan Disbursement Works
Construction lenders don't just hand over hundreds of thousands of dollars and trust that everything goes smoothly. The money moves in carefully controlled stages, and what triggers each release might surprise first-time builders.
Building a house is quite different from buying one that’s already standing, and the same is true when it comes to financing. With a construction loan, you generally don’t get all of the money upfront. Instead, the lender releases the funds in stages as different parts of the house are finished. These payments are usually called draws. This process protects the lender; instead of handing over hundreds of thousands at once, they have an opportunity to make sure the money is being used properly as the project moves along.
The Construction Draw Schedule
Before construction starts, the lender will approve the loan using things like the building plans, estimated construction costs, appraisal, and the borrower’s financial situation. The construction loan is then divided into several draws. Draw schedules vary. Many lenders use more than three draws (sometimes 4–7) based on specific construction milestones. The exact percentages and stages are dependent on the lender or the specific project, but a typical schedule might look similar to this:
Draw 1 – Around 45%
The first draw is usually the largest. It helps pay for the early stages of construction. This can include site preparation, the foundation, framing, roofing, and making the house weatherproof.
Draw 2 – Around 30%
Once the basic structure is up, the next draw is dedicated to the inside work. This tends to include rough-in plumbing and electrical work, insulation, ceilings, and drywall.
Draw 3 – Around 25%
The final draw of the construction fund goes to completely finishing the house. This mostly means final plumbing and electrical work, flooring, paint, cabinets, countertops, and other finishing touches. Before the lender releases this last amount, it may require a final inspection to verify that the house has been completed according to the plans. That can include getting a certificate of occupancy.
How the Money Is Paid
Depending on how the loan and construction contract are set up, the lender might release the money directly to the contractor or release funds through another approved process. Some lenders also offer owner-builder or self-contract construction loans , although these tend to come with extra requirements.
Before the next draw , the lender will want to verify that the previous chunk of work has been completed. This usually involves inspections.
When Do You Start Paying Interest?
Another point worth noting with a construction loan is that you pay interest only on the amount of money that has been drawn. For example, if you have a $200,000 construction loan but only $50,000 has been given to you so far, your interest payments are going to be based on that $50,000, not the entire amount. As more money is drawn to pay for construction, the amount you’re paying interest on increases.
During the construction period, payments tend to be interest-only, which keeps the monthly payment lower while the house is being built.
What Happens When the House Is Finished?
Once construction is complete and all of the loan funds have been drawn, the construction phase ends. With a construction-to-permanent loan, the loan then turns into a regular mortgage. At this point, you begin making your normal monthly mortgage payments. The exact process varies depending on more than one factor, like the lender and the type of construction loan.
With a construction-only loan, however, the borrower needs to obtain separate permanent financing once construction is finished. The new mortgage is then used to pay off the construction loan.
Don’t be afraid to ask questions. You should understand the draw schedule, inspection requirements, interest payments, and conversion process before you get started.
Contact [email protected] for any questions or corrections.
