Construction Loan

Construction loans are used by developers building commercial or residential projects and by individuals building their own homes. Unlike ordinary mortgages, the full amount is not paid out at once. Instead, the lender releases funds in stages, called draws, after inspecting the work completed.

Interest is usually charged only on the amount drawn so far. When construction is finished, the loan is typically repaid from the sale of the property or refinanced with a long-term mortgage or investment loan.

For example, a developer building apartments might receive a construction loan covering 60% of the project’s costs, with the developer providing the rest as equity. Money is released as the foundations, frame and interior are completed.

Construction loans are riskier for lenders than mortgages on completed properties, because projects can face cost overruns, delays, planning problems or falling demand before completion. As a result, they typically carry higher interest rates, require larger deposits and involve closer monitoring. Lenders measure risk using ratios such as loan-to-cost and loan-to-value.