Construction Loans for Real Estate Investors: Draw Schedules, Rates, and Exit Strategies

    FinancingBy the Home Nexio Editorial Team6 min read

    You've found a lot, drawn up plans, and lined up a contractor. Now your mortgage broker tells you the deal needs a construction loan — and suddenly you're learning an entirely different product with inspections, draw schedules, and a loan that expires in 18 months. Construction loans are powerful tools, but they're actively managed financing: you don't get the money upfront, you earn it draw by draw as work gets done.

    What a Construction Loan Actually Is

    A construction loan is a short-term, interest-only line of credit secured by the land and the improvements being built on it. The loan has a committed amount — say $500,000 — but you don't pay interest on $500,000 from day one. You pay interest only on funds actually drawn. As your contractor completes work, you submit draw requests, the lender inspects, and funds are released into a construction escrow account or directly to your account. Terms typically run 12-18 months for residential projects and up to 24 months for larger commercial builds.

    Interest carry math: If you draw $300,000 evenly over 12 months at 10%, your average outstanding balance is roughly $150,000. That means total interest during construction is approximately $15,000 — not $30,000 on the full amount. Front-loaded draws increase carry costs; back-loaded draws reduce them.

    Two-Time Close vs. One-Time Close

    There are two structures, and choosing the right one affects your total closing costs and rate exposure significantly.

    • Construction-to-permanent (one-time close): You close once. The loan automatically converts to a permanent mortgage when construction is complete. You pay one set of closing costs, and your permanent rate is locked at the time of construction closing. This eliminates the rate risk of having to refinance into a rising-rate environment after you've built.
    • Construction-only (two-time close): You take out a standalone construction loan, build the project, and then refinance into a separate permanent mortgage or sell the property. You pay closing costs twice. The advantage is flexibility — you can shop for the best permanent financing once the project is stabilized, or you can sell rather than hold. For investors doing house flips or build-to-sell projects, the two-time close is typically the right structure.

    Down Payment and Loan-to-Cost Requirements

    Construction lenders underwrite against loan-to-cost (LTC) and loan-to-value (LTV) on the completed project. Expect to bring 20-25% of total project cost as equity — that includes the land if you already own it (your equity in the land counts). A project with $150,000 in land and $350,000 in construction costs has a $500,000 total project cost. At 80% LTC, the lender funds $400,000; you bring $100,000. Some lenders also cap the loan at 70-75% of the "as-completed appraised value," so if the finished home appraises at $480,000, their ceiling is $336,000-$360,000 regardless of your costs. That math can create a gap you need to fund with cash or a second lien.

    Lender checklist: Approved building plans and permits, licensed and insured general contractor, detailed construction budget with cost breakdown by trade, builder's risk insurance naming the lender as additional insured, and appraisal based on plans and specs (not a comparable-only analysis).

    How the Draw Schedule Works in Practice

    Before your loan closes, you and your lender agree on a draw schedule tied to construction milestones. A typical residential new build might look like: Draw 1 at foundation completion (15% of budget), Draw 2 at framing (25%), Draw 3 at mechanical rough-in (20%), Draw 4 at drywall and insulation (20%), Draw 5 at finish work and certificate of occupancy (20%). When you hit a milestone, you submit a draw request with invoices and lien waivers from your contractors. The lender's inspector visits the site — typically within 3-5 business days — verifies the work, and approves the draw. Funds hit your account within another 2-3 days. The cycle repeats for each draw.

    Lien waivers from subcontractors are critical at each draw. Without them, subs who weren't paid by your GC can file mechanics' liens against the property — which can encumber your title and halt your construction-to-perm conversion. Many lenders require conditional lien waivers before releasing draws and unconditional waivers after payment clears.

    Ground-Up Builds vs. Major Renovation Loans

    Construction loans aren't just for vacant lots. A major gut renovation — where you're essentially rebuilding a structure from the foundation up — can qualify for construction financing rather than a standard rehab loan. The distinction matters because hard money lenders who fund fix-and-flip projects typically won't touch a project that requires structural work, new mechanical systems, and permits across multiple trades. If your renovation budget exceeds 50-60% of the property's current value, you're in construction loan territory.

    The BRRRR strategy — buy, rehab, rent, refinance, repeat — can work with a construction loan on major rehabs, with the exit being a cash-out refinance once the property is stabilized and leased.

    Exit Strategies When Construction Is Complete

    Your construction loan has a maturity date. When it comes due, you need a plan — lenders don't simply extend indefinitely because the market is soft.

    • Sell on completion: For build-to-sell investors, this is the cleanest exit. List the property immediately after the certificate of occupancy is issued and use sale proceeds to pay off the construction loan. Make sure your loan term gives you enough runway to sell — in slower markets, getting to closing can take 60-90 days after you go under contract.
    • Convert to permanent mortgage: One-time close loans convert automatically. Two-time close loans require you to apply for and close a new permanent mortgage. Start the application process 60-90 days before your construction loan matures.
    • Cash-out refinance into a rental portfolio: If the property appraises above your total project cost, a cash-out refinance can return your equity for reinvestment while leaving the property as a rental. Alternatively, a DSCR loan works well for investment properties because it qualifies based on rental income rather than your personal tax returns.
    • Bridge loan: If you need more time — the market is slow or the permanent loan is delayed — a bridge loan can pay off the construction loan and give you another 6-12 months of runway. Expect a higher rate, but it's better than a forced sale.

    What Can Go Wrong (And How to Protect Yourself)

    Construction projects run over budget and over schedule with remarkable consistency. A 10-15% contingency reserve isn't pessimism — it's standard underwriting. Before you close, verify that your contractor has pulled every required permit. Unpermitted work won't pass the draw inspection and can create title problems that follow the property indefinitely. Make sure your builder's risk insurance is in place before the first draw — a fire or storm during construction on an uninsured project is a total loss against which the lender will still collect.

    The investors who get hurt by construction loans aren't usually the ones who build badly — they're the ones who run out of time. Build your timeline with 20% more duration than your contractor promises, then add another 30 days for permit delays and inspection scheduling. If you finish early, great. If you don't, you won't be scrambling for a bridge loan at the worst possible moment.

    Frequently Asked Questions

    How do draw inspections work on a construction loan?

    Before the lender releases each draw, they send an inspector (or a third-party inspection company) to verify that the work claimed in the draw request has actually been completed. The inspector checks progress against the approved budget and scope. If the work is verified, the lender wires funds — typically within 2-5 business days. If the work is incomplete or deficient, the draw is delayed or reduced until the issues are resolved. Most loans have 3-6 draws built into the schedule, so planning your contractor payment schedule around these milestones is essential.

    What is the difference between a construction loan and a hard money rehab loan?

    Hard money rehab loans (fix-and-flip loans) are designed for properties that are being renovated but already have a foundation and structure standing — you're improving an existing building. Construction loans fund ground-up builds or demolition-and-rebuild projects where there's no completed structure yet. Construction loans typically have longer terms (12-18 months vs. 6-12 months for hard money), stricter documentation requirements (plans, permits, licensed contractor), and may require a larger down payment. Hard money lenders are generally more flexible on credit and move faster; construction lenders underwrite the project more like a bank.

    Can I be my own general contractor on a construction loan?

    Some lenders allow owner-builder arrangements, but most institutional lenders and banks require a licensed general contractor with a verifiable track record. If you're allowed to owner-build, expect tighter scrutiny, a higher interest rate, and potentially a reduced loan-to-cost ratio. Lenders worry that inexperienced owner-builders will run over budget, miss deadlines, and create a partially completed property that's difficult to sell or refinance. If you want to self-manage construction, partnering with a licensed GC of record — even if you're doing much of the coordination yourself — is often the cleaner path to loan approval.

    What happens if my construction project goes over budget?

    Cost overruns are your responsibility. Once the loan is set, the lender won't simply hand you more money because materials got more expensive or a subcontractor walked off the job. Most lenders require a contingency reserve of 10-15% of the construction budget built into the loan at closing to cover overruns — draw that down first. If you burn through contingency, you'll need to bring cash to the table or negotiate a loan modification, which requires lender approval and additional fees. This is why detailed, contractor-reviewed budgets and locked-in material pricing before closing are worth the extra pre-closing work.

    How do construction loan rates compare to permanent mortgage rates?

    Construction loan rates are higher than long-term permanent mortgages. For investors, expect rates in the 8-12% range on a fixed basis, or prime rate plus 1-2 percentage points on a variable basis. As of early 2026 with prime around 7.5%, a prime-plus-2 construction loan would be around 9.5%. Permanent 30-year investment property mortgages typically run 1-2 percentage points lower than construction loan rates. The rate differential is one reason minimizing your construction timeline matters — every extra month of carry costs at 10% on a $400k draw balance is roughly $3,300 in interest.

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