Ground-Up Construction Loans, Explained

How does construction financing differ?

A construction loan is different from a purchase loan because the collateral is being created during the loan. At the start there may be only land and a set of plans; at the end there is a completed building. That is why construction loans use a draw schedule, with funds released as the project reaches milestones and each draw verified by an inspection.

Construction also carries different risks: cost overruns, permit delays, weather and contractor problems. Lenders manage that risk with a detailed budget, contingency allowances, inspections and a close watch on the schedule.

What does the construction lender underwrite?

• The land value and how it was acquired.
• A detailed construction budget with hard and soft costs.
• Plans, permits and a contractor with a track record.
• The projected value of the finished building.
• The exit plan: sale of the finished building or a permanent-loan refinance.

How does the draw process work?

The draw schedule for construction is usually tied to physical milestones such as foundation, framing, rough-in, drywall and final. Before each draw, an inspector confirms the completed work, and the lender releases funds for that stage. A retainage is often held until the project is finished and final inspections pass.

The paperwork is similar to a rehab draw schedule but more detailed: a line-item budget, contractor invoices, lien waivers and inspection reports. See the rehab draw schedule guide for the mechanics.

How should you plan the exit?

Construction loans are short-term, so the exit is part of the plan from the beginning. A builder might sell the finished building, or hold it as a rental and refinance into a DSCR loan once it is leased. If the plan is a refinance, compare expected rent with the full proposed refinance payment using the DSCR exit guide before you break ground.

Hard Money Loan is a Loan Daddy LLC brand. Loan Daddy LLC is a mortgage broker, not a lender, and arranges construction financing through wholesale lenders. See the ground-up construction page for the full overview.

What are hard costs, soft costs and contingency?

A construction budget has two halves. Hard costs are the physical build: site work, foundation, framing, roofing, mechanical systems, finishes and landscaping. Soft costs are everything else the project needs: architecture and engineering, permits and impact fees, surveys, insurance, utility connections, interest carried during the build, and legal and closing costs. Lenders look at both, and an incomplete soft-cost list is a frequent reason a construction budget gets sent back.

Every serious budget also carries a contingency line for the surprises construction always produces, such as soil conditions, material price changes and inspector requests. A budget without a contingency assumes nothing goes wrong. Lenders read a realistic contingency as a sign that the builder understands the work.

What should builders prepare before applying?

• Proof of land ownership or a land purchase contract, and how the land was paid for.
• Stamped plans and specifications, or a clear timeline for getting them.
• Permit status, or a realistic estimate of when permits will issue.
• A line-item budget covering hard costs, soft costs and contingency.
• A construction schedule broken into milestones that match the draw schedule.
• The general contractor’s license, insurance and a list of completed projects.
• Your own experience building or renovating, and the role you will play on site.
• The exit plan: a listing strategy for a sale, or the expected rent for a DSCR refinance.

How do experience and the contractor affect financing?

Construction lenders pay close attention to who is building. A builder with completed projects of a similar size and type will usually see more program options than someone attempting a first build. A first-time builder can still find financing in some cases, especially with an experienced general contractor and a straightforward plan, but should expect more questions and more conditions.

The type of project matters too. A single-family spec home on a finished lot in an established subdivision is a simpler file than a small multifamily building on raw land that still needs utilities and entitlements. The more steps between the land and a finished building, the more the lender will want to see before it commits.

Which construction-loan mistakes should you avoid?

• Leaving soft costs, utility connections or impact fees out of the budget.
• Breaking ground before permits and the draw schedule are settled.
• Choosing a contractor who has never worked with inspected draws.
• Building finishes the eventual buyer or tenant will not pay for.
• Waiting until the building is finished to think about the sale or the refinance.

How does land ownership affect the loan?

How you hold the land shapes the construction file. If you already own the lot free and clear, the equity in the land may count toward your contribution to the project, if the lender allows it. If the lot is under contract, the construction loan may be structured to fund the land purchase and the build together. If the land carries an existing loan, that loan usually has to be paid off or subordinated at closing.

Raw land also needs more work before it can be built on than a finished lot: surveys, utility access, entitlements and sometimes environmental review. Each of those steps adds time and cost to the budget, and lenders will want to see them accounted for before the first draw. If you are still choosing a site, compare a finished lot and a raw parcel on the total cost to a buildable condition, not just the purchase price.