A construction loan is a short-term facility that funds the development or major renovation of a commercial real estate property. Proceeds are disbursed through a draw schedule as the borrower meets construction milestones, and interest is paid only on the amount drawn. Construction loans are typically floating-rate, priced at a spread over SOFR, with terms of 18 to 36 months.
How is a construction loan funded?
Unlike a permanent loan, where the full balance is funded at closing, a construction loan advances money in draws. The draw schedule is the heartbeat of the loan: each draw request must be accompanied by an inspection report, lien waivers from subcontractors and evidence that the project is on budget and on schedule. If the project falls behind or runs over budget, the borrower may need to inject additional equity before the lender releases the next draw.
Lenders underwrite construction loans on the project’s projected stabilized value and income, the borrower’s development experience and the general contractor’s qualifications.
How does a construction loan differ from a bridge loan?
Both are short-term and floating-rate, but a bridge loan funds an existing property through a repositioning while a construction loan funds a building that does not yet exist or is being substantially rebuilt. Because the construction period may last two or more years, interest rate risk is a significant concern, and many lenders require the borrower to purchase an interest rate cap.
The transition from construction loan to permanent financing, known as the take-out, is a critical milestone that must be planned from day one.
How construction loans show up in LoanBoss
Draws are entered on the day they are made, with each loan’s floating index, daycount convention and business day adjustment. Critical date alerts, hedges with live rates and MtMs, recourse burndown and escrow tracking cover the rest of the loan, and LoanBoss tracks budget-to-actual progress and the construction-to-permanent timeline.
Frequently Asked Questions
How long is a construction loan?
Typically 18 to 36 months, depending on the project scope, after which permanent financing takes the loan out.
Do I pay interest on the full construction loan amount?
No. Interest accrues only on the amount drawn to date, so debt service starts low and grows as the project is funded.
What do lenders look at when underwriting a construction loan?
The project’s projected stabilized value and income, the borrower’s development experience and the general contractor’s qualifications.
Related Terms
- Draw Schedule
- Bridge Loan
- Interest-Only
- Good-News Money
- Interest Rate Cap
- Construction-to-Permanent Loan
- Loan-to-Cost (LTC)
- Construction Loan Draw Tracking for Real Estate Developers: The Borrower’s Side
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary