Construction financing

How it works

Construction finance commonly releases money in stages as work progresses. Lenders review costs, contractor arrangements, permits, contingency, and the project’s repayment or takeout plan. Draws may depend on inspections or other evidence.

Where it can fit

Cash timing is central: suppliers and contractors may require payment before a draw can be released. Model that gap and consider retention, change orders, and interest during construction.

Look closely at the trade-offs

Cost overruns and delays can require extra equity. The approval of a facility does not make every draw automatic. Confirm conditions, lien requirements, who funds overruns, and the financing available when construction finishes.

A commitment is not cash already in the bank

Construction funding often moves through draws tied to progress and evidence. The OCC’s CRE handbook describes draw administration and completion controls for U.S. banks. Your agreement determines what must be supplied, what is withheld and when payment occurs. Ask the lender to walk through a sample draw before the contractor expects the first payment.

Source: OCC: Commercial Real Estate Lending handbook · BDC: Commercial real estate financing

Worked example: a draw can leave a temporary gap

A fictional project has a $600,000 construction budget, including a $50,000 contingency. This month the contractor bills $80,000. Assume the lender approves the full work value but withholds 10% under the illustrative agreement, so only $72,000 is released at that stage. If the contractor is contractually entitled to $80,000 now, the borrower must address an $8,000 timing gap. This invented holdback is not a statement of local statutory requirements.

Later, approved change orders total $65,000. They exceed the original contingency by $15,000 before any delay-related interest, rent or overhead. A lender is not automatically committed to fund that excess. Update the cost-to-complete schedule and identify the confirmed source for the extra money before assuming the project remains fully funded.

Connect progress, costs and the takeout plan

Maintain a schedule showing original budget, approved changes, amount paid, amount still payable and remaining contingency. Reconcile it with the contractor’s reports and lender draws. Distinguish completed work from materials ordered or stored off-site. Ask which evidence the lender requires for each category and how long review normally takes without treating an estimate as a guaranteed funding date.

The final stage needs its own financing plan. If the construction facility is repaid by sale or a long-term mortgage, identify the conditions for that event and test delays. Legal requirements for liens, holdbacks, permits and occupancy vary, so have local advisers align construction contracts with the financing documents. A finished building and an approved long-term loan are separate milestones.

Before the first draw, reconcile the lender’s process with the contractor’s payment schedule. If invoices are due sooner than inspections or reimbursements can occur, identify the temporary funding source and the person responsible for arranging it. Repeat this check after a material schedule change. A project can be within its total budget and still experience a serious cash interruption when the timing of approved advances does not match the timing of contractual payments.

• What documents and inspections support each draw?
• Who pays overruns, holdbacks and costs incurred before reimbursement?
• Which changes require lender approval?
• What must happen for the final draw and long-term repayment source?

Your next-step checklist

• Detailed budget and contingency
• Permits and contractor agreements
• Draw and inspection schedule
• Completion and takeout financing