There’s something uniquely thrilling about standing on an empty lot and imagining the building that could rise there. A duplex, a custom home, a fourplex rental. But while the vision is exciting, the financing is rarely simple. New construction loans are among the most complex products in real estate — part mortgage, part line of credit, part trust exercise between lender, borrower, and builder.
What is a Construction Loan?
A construction loan is short-term financing used to fund ground-up builds or major redevelopment. Unlike buying a finished property, where a lender releases the full loan at closing, construction loans are structured around draws. Funds are released in stages as work is completed and inspected.
Types of Construction Loans
- Construction-to-Permanent: One loan that converts to a mortgage upon completion.
- Stand-Alone Construction: Short-term loan requiring separate permanent financing at completion.
- Investor Construction Loans: Tailored to builders and developers, often from private lenders or banks with higher risk appetite.
Investor Story: A Builder’s First Fourplex
Alex, a small-time investor, wanted to build a fourplex on an infill lot. He secured a 12-month construction loan at 10% interest. The lender disbursed funds in five draws: foundation, framing, rough-ins, finishes, and completion. When supply chain delays doubled the cost of lumber, Alex had to inject personal capital to keep the project moving. Despite the stress, the project appraised well, refinanced into a DSCR loan, and now cash flows $1,400 per unit monthly. The takeaway? Construction loans reward preparation and liquidity.
Investor Story: The Permit Nightmare
Sophia lined up financing for a custom home, but the city’s permit office delayed approvals for nine months. Her loan term expired before a shovel hit the ground. She paid thousands in extension fees and had to renegotiate with her builder. The lesson? Regulatory risk is as real as budget risk.
How Construction Loans Work
Lenders structure these loans differently from purchase loans:
- Loan funds sit in escrow, released in stages.
- Each draw requires inspection or builder’s affidavit.
- You pay interest only on funds disbursed, not the full loan.
- Terms are short (12–24 months), often with extension fees.
Typical Terms in 2025
| Term | Range |
|---|---|
| Length | 12–24 months |
| Rates | 9–12% (private) or 7–9% (bank) |
| Points | 2–4 |
| LTV | 65–75% of cost, sometimes 70–75% of ARV |
| Draws | 4–6 stages, reimbursement after inspection |
Budgeting for Construction
Budgets for ground-up builds are notoriously fragile. Material prices fluctuate, subcontractors change bids, and delays burn reserves. Smart investors build in:
- 10–15% contingency reserve.
- Firm bids from contractors before loan closes.
- Realistic timelines that account for inspections and weather.
- Extra liquidity to float costs between draws.
Risks Unique to Construction
- Permits & Zoning: Delays here can kill deals before they start.
- Cost Overruns: Lumber, labor, and materials fluctuate wildly.
- Draw Timing: Delayed inspections mean delayed funds.
- Exit Strategy: Market shifts can make refis harder once the build is done.
Case Study: Lumber Spike of 2021
During the pandemic, lumber prices tripled. Investors who budgeted thinly were wiped out. Those who had contingencies survived, some even profiting as demand for new builds soared. The lesson: expect the unexpected.
Checklist: Before Taking a Construction Loan
- Do I have builder bids locked in?
- What’s my contingency reserve?
- Do I understand the draw process?
- What happens if permits take 6–12 months?
- What’s my exit (refi, sale, hold)?
FAQs
Do I need experience to qualify? Some lenders require builder or investor experience. First-timers may need partners.
Can I finance land too? Often yes, but lenders cap total exposure based on cost-to-complete.
What about interest-only payments? Common. You pay interest only on funds disbursed, not the entire loan.
What if the market shifts before completion? Stress-test your exit at higher rates and lower values.
Bottom Line
Construction loans let you create value where none existed, but they demand discipline. They aren’t just about building walls—they’re about building budgets, timelines, and trust with lenders. If you can master the complexity, the rewards of ground-up development in 2025 are worth the risk.
