Construction loans get confused with fix and flip financing constantly, and it's easy to see why — both fund work in phases through draws instead of handing over cash at closing. But building a property from the ground up is a different risk profile than renovating one that already exists, and the loan structure reflects that. Here's how ground-up financing actually works.

What a construction loan actually funds

A construction loan typically covers:

  • Land acquisition — if you don't already own the lot
  • Hard costs — materials, labor, site work
  • Soft costs — permits, architectural and engineering fees, inspections
  • An interest reserve — funds set aside to cover interest payments during the build, so you're not paying out of pocket while the property generates no income

Like a fix and flip loan, funds beyond the initial land/acquisition draw are released in stages as construction progresses and is verified — not handed over up front.

Loan-to-cost vs. loan-to-value

Most construction lenders size the loan primarily against loan-to-cost (LTC) — the percentage of total project cost (land + hard costs + soft costs) the loan will cover — rather than loan-to-value on the finished product. You're generally expected to bring meaningful cash equity into the project yourself, which aligns your incentives with the lender's and demonstrates you can absorb cost overruns without abandoning the project.

The lender will also want to know the projected value of the finished property (similar to ARV in a flip) to confirm the deal makes sense on the back end — but the loan amount itself is driven by cost, not by that eventual value.

Illustrative example

Land: $80,000. Hard costs: $280,000. Soft costs: $25,000. Total project cost: $385,000.

A lender financing a meaningful majority of that cost would still require the investor to fund the remaining balance in cash equity — the exact split depends on the lender, your experience, and the project.

This is a hypothetical example for illustration only, not a quote.

The draw process

Construction draws work on the same basic principle as fix and flip draws, just against a more detailed schedule tied to construction milestones — site work, foundation, framing, mechanicals, drywall, finishes. Each draw request is typically backed by an inspection confirming the work is complete before funds release. A detailed, milestone-based draw schedule agreed on upfront makes the entire process faster and more predictable than a vague, lump-sum budget.

Why the interest reserve matters

Because a construction project produces no income while it's being built, most construction loans include an interest reserve — a portion of the loan set aside specifically to cover monthly interest payments during the build period. This keeps your cash flow from being strained by loan payments on a property that isn't generating rent or sale proceeds yet. It's worth confirming upfront how the reserve is calculated and whether it's sized realistically for your actual timeline, including likely delays.

What happens when construction finishes: the take-out loan

A construction loan is short-term by design — it's not meant to be held once the building is complete. When construction wraps up, investors typically do one of two things:

  1. Sell the finished property, paying off the construction loan from sale proceeds — essentially the same exit as a fix and flip.
  2. Refinance into permanent financing — often a DSCR loan once the property is leased and producing income, or a conventional/commercial loan depending on the property type.

This second option is often called a "take-out loan," because it takes out (pays off) the construction loan. Planning your take-out strategy before you break ground — not after the building is finished — avoids getting stuck holding an expensive short-term loan with no clear exit.

What lenders look for

  • Builder/GC experience. A qualified, vetted general contractor with a track record matters as much as your own experience as the investor.
  • A realistic, detailed budget. Line-item costs, not round-number estimates.
  • Permits and plans in hand, or close to it. Lenders want to see a project that's ready to move, not one still working through entitlements.
  • A credible contingency. Construction almost always costs more than the first budget — a thin or nonexistent contingency is a red flag.

Getting started

Bring the numbers that matter most: land cost (or basis, if already owned), a detailed hard and soft cost budget, your general contractor's background, and your intended exit — sale or refinance into permanent financing.