How Ground-Up Construction Loans Work: LTC, Draws, Interest Reserve and Completion Risk

Begin with a project that is ready to be underwritten

Construction financing connects a site, plans, approvals, budget, contractor, schedule and exit. If one part is unresolved, the loan amount alone cannot make the project ready.

Before sizing the loan, establish:

Faundare Capital's current Ground-Up Construction orientation focuses on shovel-ready residential investment projects and connects site readiness, plans, permits, budget, contractor capability, sponsor experience, contingency and exit.2 Published parameters are an initial orientation rather than a commitment.

Starting construction before the financing plan is reconciled can create unpaid work or completed improvements that do not satisfy the eventual lender's eligibility and inspection requirements. The closing checklist therefore belongs before contractor mobilization, not after the first draw is needed.

Separate commitment, closing advance and future advances

The loan commitment is the maximum approved principal subject to the loan's conditions. It can contain several controlled components:

Cash delivered at closing can therefore be far below the commitment. If a $675,000 loan provides $105,000 toward the lot at closing and holds $570,000 for future construction and interest advances, the borrower has not received $675,000 of spendable cash. The undisbursed amount is conditional financing, not a deposit account.

The distinction also affects repayment. A lender may charge interest only on principal actually advanced, or the documents may apply a different convention. Confirm the interest-bearing balance, when each reserve advance becomes principal and whether unused commitment is subject to a fee.

Calculate LTC from the lender's accepted cost basis

Loan-to-cost compares the construction loan with a defined project-cost denominator:

LTC = construction loan commitment ÷ lender-defined total project cost

“Total project cost” is not self-defining. The lender may accept documented land basis, eligible hard costs, selected soft costs, contingency and an approved interest reserve while excluding sponsor overhead, unsupported allowances, premiums paid above accepted land value or work outside the approved scope. Ask for the cost schedule used in underwriting rather than dividing by the sponsor's gross budget and assuming the result matches the term sheet.

Assume this hypothetical project:

The commitment equals 84.4% LTC on the $800,000 gross cost. The borrower must identify at least $125,000 for the modeled permanent difference: $45,000 of lot equity, $50,000 of soft costs, $20,000 of contingency outside the commitment and $10,000 of carry outside the reserve. Closing costs and temporary draw liquidity can require additional cash.

Faundare Capital's current program orientation uses a regular lot advance of up to 70% of the accepted basis, with a 75% maximum for qualifying scenarios. It also states up to 100% of eligible construction costs and up to 90% of total project cost.2 Those percentages apply to different bases and remain subject to the complete project and sponsor review. “100% of construction” does not mean 100% of the total project, and a 90% LTC ceiling does not establish the amount available at closing.

Apply every loan-sizing constraint

The commitment may be limited by more than LTC. Depending on the approved program, underwriting can also constrain:

• the advance against the lot's accepted acquisition cost or value;
• the percentage of eligible hard and soft costs;
• the completed or stabilized value;
• minimum borrower equity;
• the interest and carry budget;
• sponsor liquidity and experience; and
• the sale or permanent-refinance exit.

The lowest supportable result controls. Increasing one component does not necessarily increase the commitment. If the appraisal supports a lower completed value, the value limit can bind even when the project remains below maximum LTC. If $40,000 of the construction budget is unsupported, removing it from eligible cost can both reduce funded uses and change the LTC denominator.

Reconcile the final approval to a sources-and-uses table. Every project use should have one identified source—loan, borrower equity, third-party capital or project revenue—and every source should have a documented time when it becomes available.

Follow the equity and draw sequence

Construction funds are commonly advanced through construction draws, but the funding order varies. The loan agreement may require borrower equity before loan advances, proportional funding, a defined first-loss contribution or another sequence. Land equity credit may depend on documented basis, current value, how long the lot has been owned and whether existing liens are repaid at closing.

For each draw:

1. Reconcile completed work with the approved schedule of values.
2. Confirm invoices, payment evidence, change orders and any required lien documents.
3. Provide access for the required inspection or progress verification.
4. Apply budget-line limits, prior advances, retainage, fees and approved reallocations.
5. Record the approved gross draw, deductions, net proceeds and remaining holdback.
6. Update the cost to complete and the next contractor-payment window.

The FDIC's current construction-lending examination module emphasizes comparing draws with actual completion, guarding against front loading and determining whether the undisbursed balance remains sufficient to complete the project.3 That supervisory framework applies to insured institutions, while the approved private-loan process controls the transaction. The underlying borrower question is the same: after this draw, are enough committed funds and verified equity still available to finish every remaining obligation?

An inspection supporting a draw is not a comprehensive warranty of workmanship or a municipal code approval. The owner still needs contract administration, required governmental inspections and quality controls.

Model the borrower's construction liquidity

Even fully eligible work can create a temporary cash requirement. Contractors may require deposits or progress payments before the lender completes an inspection and releases the draw. Stored materials, off-site fabrication and deposits can also receive different treatment.

Track two separate amounts:

Permanent borrower funding = total project uses − total usable loan proceeds − other committed sources

Peak draw liquidity = maximum over time (eligible cash paid − eligible reimbursements received)

Do not add the peak draw gap to permanent equity without considering reuse. Reimbursed cash can fund later work. The schedule still must prove that the investor can carry the largest unreimbursed balance while preserving funds for ineligible costs, overruns and operating obligations.

The companion article How to Build a Ground-Up Construction Budget and Draw Schedule develops the line-item budget, retainage and monthly draw model in detail.

Understand what the interest reserve does

An interest reserve is a restricted source for scheduled loan interest during construction and, when approved, part of the period before sale or permanent financing. It does not eliminate interest. A loan-funded interest advance usually increases outstanding principal, which can cause later interest to accrue on a larger balance under the note's calculation method.

The OCC explains that an appropriate reserve should be based on the construction and lease-up schedule, expected loan advances and estimated interest through the intended repayment event. It also warns that a reserve can mask a poorly performing project when it is used without reassessing progress and repayment.4

Assume the example loan charges 10% annual interest on the approximate average funded balance for each two-month period:

The $40,000 reserve is already about $917 short in this simplified schedule. Three additional months at a $665,000 balance add approximately $16,625, before extension charges, taxes, insurance or operating costs. The exact loan uses daily balances and the note's accrual convention; the table shows why the reserve must be tested against the draw schedule rather than selected as a round percentage.

Measure reserve runway monthly:

Interest-reserve runway = remaining reserve ÷ projected monthly interest and approved reserve uses

If the runway ends before completion or exit, identify the approved funding source immediately. Do not assume the lender will increase the commitment or reallocate hard-cost funds.

Recalculate cost to complete after every material change

Cost to complete is a forward-looking obligation, not the original budget less invoices already paid. It includes executed but unpaid contracts, pending and approved changes, unfinished base scope, stored materials, retainage, closeout work and credible unresolved exposures.

Assume that midway through the example project:

Only $215,000 remains in the eligible construction and contingency holdbacks. The borrower has $28,000 of verified uncommitted construction cash. Available completion funding is therefore $243,000, producing a $7,000 shortfall.

The project is not fully funded merely because the original budget balanced or the property is more than halfway complete. Before approving optional work or another draw, the parties must identify an acceptable source for the $7,000 and test whether the amount affects interest, schedule or exit. Restricted interest reserves should remain separate unless the lender expressly approves a reallocation and the revised interest plan still works.

Cost overruns do not automatically increase the loan. The loan documents may require the borrower or guarantor to fund overruns, replenish reserves or complete the project regardless of whether the remaining commitment is sufficient. Review completion obligations and guarantees with counsel before closing.

Protect the completion and exit period

Physical completion, legal completion and financing completion can occur on different dates. The final draw may require punch-list work, final inspections, lien releases, invoices, certificates, permit closeout and other documents. A sale or refinance can add appraisal, title, insurance, underwriting and closing time after construction is substantially complete.

The maturity should cover:

• construction duration under a realistic schedule;
• weather, inspection, utility and procurement delay;
• final draw and closeout documentation;
• marketing and buyer diligence for a sale; or
• stabilization and permanent-loan closing for a refinance.

An extension may require lender approval, updated underwriting, an extension fee, interest-reserve replenishment or principal reduction. Treat it as a conditional option unless the documents grant it on clearly satisfied terms.

For a sale exit, deduct brokerage, transfer, legal and closing costs as well as the complete loan payoff. For a refinance exit, size permanent proceeds using supportable value, income and current loan terms. Gross completed value is not payoff cash.

Decide whether the structure is fully executable

Before closing, the reconciled model should answer:

1. What funds at closing? Identify the exact lot advance, payoff, fees and borrower cash rather than quoting the total commitment.
2. Which costs are eligible? Reconcile every budget line with the lender's accepted cost schedule and draw conditions.
3. How is leverage constrained? Calculate LTC on the disclosed denominator and test any lot, completed-value and equity limits.
4. How much cash is required during construction? Add permanent borrower funding, peak draw liquidity and reserves that remain unrestricted.
5. Will the interest reserve last through a conservative exit date? Model the actual draw curve and a delay case.
6. Can the project still finish after a change? Compare remaining holdbacks and verified equity with updated cost to complete after every material event.
7. What repays the loan before maturity? Support the sale or permanent-refinance proceeds, deductions, conditions and closing time.

Review Faundare Capital's current Ground-Up Construction program after the project inputs are assembled.2 The useful loan amount is the amount that can close, fund the approved work in the required sequence and leave a credible path to completion and repayment.