Ground-Up Construction Financing: Everything Investors Need to Know

Ground-up construction financing is a specialized loan product designed to fund the building of a new structure from an empty lot or demolished site. Unlike standard mortgages that finance existing properties, construction loans fund a project that does not yet exist, which creates a unique set of risks, requirements, and processes for both the lender and the borrower.

Construction loans are fundamentally different from traditional real estate loans in several important ways. First, the loan is disbursed in stages (called draws) as construction progresses, rather than as a single lump sum at closing. Second, the collateral is an unfinished building that changes in value as work is completed, requiring ongoing monitoring. Third, the borrower is typically paying interest-only on funds that have been disbursed, not on the full loan amount, until the project is complete.

For real estate investors, ground-up construction can be enormously profitable. Building new allows you to capture the full development margin between construction costs and market value, customize the product to market demand, and avoid the hidden surprises that come with renovating old structures. However, construction projects also carry more risk than rehab projects due to longer timelines, more moving parts, and higher capital requirements.

Construction financing is available from banks, credit unions, and private or hard money lenders. Each source has different requirements, costs, and processes. Private construction lenders tend to be faster and more flexible, while bank construction loans offer lower rates but require extensive documentation and longer approval timelines.

The draw schedule is the backbone of any construction loan. It defines when and how loan funds are released to the borrower as the project progresses through predefined construction milestones. Understanding draw schedules is essential because they directly impact your cash flow, contractor relationships, and project timeline.

A typical draw schedule divides the construction process into 4 to 8 stages, each representing a major construction milestone. Here is a common example for a single-family home build:

Draw 1: Land Acquisition and Site Preparation (15% to 20%). Covers the land purchase (if not already owned), site clearing, grading, utility connections, and foundation excavation. This draw is typically funded at or shortly after closing.

Draw 2: Foundation and Framing (20% to 25%). Released once the foundation is poured and cured and the framing (structural skeleton) of the building is complete. An inspector verifies that the work matches the approved plans.

Draw 3: Rough-In Systems (15% to 20%). Covers rough plumbing, electrical wiring, HVAC ductwork, and insulation. These systems are inspected before walls are closed up, as they will be inaccessible once drywall is installed.

Draw 4: Drywall and Interior (15% to 20%). Funds drywall hanging and finishing, interior painting, cabinet installation, and initial flooring work.

Draw 5: Finishes and Final Systems (15% to 20%). Covers countertops, fixtures, appliances, finish flooring, trim, hardware, and final HVAC and plumbing connections.

Draw 6: Exterior, Landscaping, and Final Punch (5% to 10%). The final draw covers exterior finishes (siding, painting), landscaping, driveways, final inspections, and punch list items. Some lenders hold back 5% to 10% of the total loan as a completion holdback, released only when the certificate of occupancy is issued.

Before each draw is released, the lender sends an inspector (or uses a third-party inspection service) to verify that the work described in the draw request has been completed satisfactorily and matches the approved plans and specifications. This inspection process typically takes 3 to 7 business days. Experienced investors plan their cash flow around these inspection timelines to avoid paying contractors out of pocket while waiting for draws.

Some lenders allow flexible draw schedules with more frequent, smaller draws (monthly or bi-weekly), which can improve cash flow management. Others are rigid about milestone-based draws. Clarify the draw process, frequency, inspection requirements, and funding timelines before you commit to a lender.

Construction loan underwriting is more complex than standard mortgage underwriting because the lender is financing a project, not just a property. Here is what lenders evaluate during the approval process.

Borrower Qualifications: Lenders assess your credit score (typically 680+ for banks, 620+ for hard money), liquidity and reserves, real estate investment experience, and construction experience. First-time builders face more scrutiny and may need to demonstrate that they have hired experienced general contractors and project managers.

Project Plans and Specifications: You must provide complete architectural plans, engineering drawings, and detailed specifications. These documents should be stamped by licensed professionals and comply with local building codes. Lenders review plans to ensure the project is feasible and the finished product will appraise at or above the projected value.

Detailed Construction Budget: Submit a line-item construction budget that breaks down every cost category: site work, foundation, framing, roofing, exterior finishes, plumbing, electrical, HVAC, insulation, drywall, interior finishes, flooring, cabinetry, appliances, landscaping, driveways, permits, fees, and a contingency reserve. Lenders will scrutinize this budget against comparable construction costs in the area.

General Contractor Credentials: Most lenders require a licensed, insured general contractor with a track record of completing similar projects. You will need to provide the contractor's license, insurance certificates, references, and a list of completed projects. Some hard money lenders allow owner-builders with sufficient experience, but this is less common.

Appraisal: The lender orders a construction appraisal, which estimates the property's value in two states: the current as-is value (typically just the land value) and the prospective as-completed value based on the plans and specifications. The loan amount is based on a percentage of the as-completed value, usually 65% to 75% for hard money and 75% to 80% for bank construction loans.

Permits: Before funding, lenders typically require that all major building permits have been obtained or are in process. This confirms that the project has been approved by local building authorities and reduces the risk of regulatory delays.

Title and Insurance: A clear title report, builder's risk insurance policy, and general liability coverage are standard requirements. Some lenders also require performance bonds for larger projects, which guarantee that the contractor will complete the work according to the contract.

Understanding the full cost structure of a construction loan helps you accurately project your total investment and potential returns.

Interest Rates: Bank construction loans range from 7% to 9% for well-qualified borrowers. Private/hard money construction loans range from 10% to 14%. Rates are typically variable during the construction period, tied to the prime rate or a fixed spread.

Interest Structure: During construction, you pay interest only on funds that have been disbursed, not the total loan commitment. If your total loan is $500,000 but only $150,000 has been drawn, you pay interest on $150,000. This is a significant cash flow advantage during early construction phases.

Origination and Fees: Expect 1.5 to 3 points for hard money construction loans and 0.5 to 1.5 points for bank construction loans. Additional fees include appraisal ($500 to $1,500), construction inspection fees ($150 to $300 per draw), legal and title fees, and permit fees that vary by jurisdiction.

Down Payment and Equity: Bank construction loans typically require 20% to 25% down based on the total project cost (land plus construction). Hard money lenders may require 15% to 30% down depending on the borrower's experience and the project's risk profile. If you already own the land free and clear, your equity in the land can count toward the down payment requirement.

Reserves: Lenders require cash reserves beyond the down payment, typically 6 to 12 months of projected interest payments. This ensures you can service the debt even if the project encounters delays.

Contingency Budget: Smart investors and responsible lenders build a 10% to 15% contingency into the construction budget. This buffer covers unexpected costs like material price increases, unforeseen site conditions, design changes, or weather delays. Projects that run out of contingency budget often face funding gaps that can stall construction.

Total Cost Example: Consider a single-family home build with a $100,000 land purchase and $350,000 in construction costs ($450,000 total). A hard money construction loan at 75% LTC would provide $337,500 in financing, requiring $112,500 in cash equity. At 12% interest with an average draw balance of $200,000 over a 10-month build, total interest cost would be approximately $20,000. Add 2 points ($6,750) in origination, $2,000 in inspection and legal fees, and your total financing cost is roughly $28,750. If the completed property appraises at $625,000, your gross development profit is $175,000 before selling costs.

Navigating the permitting and inspection process is one of the most challenging aspects of ground-up construction, and delays in this area are one of the most common causes of construction loan extensions and cost overruns.

Building Permits: Before any construction begins, you need a building permit from the local jurisdiction (city or county building department). The permit application requires architectural plans, structural engineering, site plans, and sometimes environmental assessments. Permit review timelines vary dramatically by jurisdiction, from 2 weeks in some rural areas to 3 to 6 months in major metropolitan areas. Factor permit timelines into your project schedule before you even apply for financing.

Zoning Compliance: Verify that your planned construction complies with local zoning regulations including setbacks, height limits, lot coverage, parking requirements, and permitted uses. If your project requires a variance or special use permit, add months to your timeline and potentially thousands of dollars in hearing fees and legal costs.

Environmental and Soil Requirements: Depending on the location, you may need soil reports (geotechnical investigations), environmental phase 1 assessments, wetland delineations, or stormwater management plans. Coastal, flood zone, and hillside properties have additional requirements that can significantly impact design and cost.

Required Inspections During Construction: Building departments conduct inspections at critical milestones: foundation (before backfill), framing (before close-up), rough mechanical, electrical, and plumbing (before drywall), insulation, drywall, and final inspection. Failed inspections require corrections before work can proceed, creating potential delays. Coordinate inspection scheduling with your contractor to minimize downtime.

Certificate of Occupancy: Upon passing the final inspection, the building department issues a Certificate of Occupancy (CO) or Certificate of Completion (CC). This document confirms that the building meets all codes and is safe for habitation. You cannot sell or occupy the property without it. Some lenders will not release the final draw or holdback until the CO is issued.

Utility Connections: Water, sewer, gas, electric, and telecommunications connections each require separate applications, fees, and potentially their own inspections. Utility connection timelines can be surprisingly long (4 to 12 weeks in some areas), so initiate these early in the construction process.

Proactive management of the permitting and inspection process is one of the biggest differentiators between experienced and novice builders. Build relationships with your local building department, hire expediting services in complex jurisdictions, and always have permits and inspections scheduled well in advance of when you need them.

Realistic timeline planning prevents cost overruns, lender frustrations, and project failures. Here is a general timeline framework for a single-family ground-up construction project.

Pre-Construction Phase (2 to 6 months): This includes land acquisition (or due diligence if you already own the lot), architectural design and engineering (4 to 8 weeks), permit application and approval (2 weeks to 6 months depending on jurisdiction), contractor selection and bidding (2 to 4 weeks), and loan application and closing (2 to 6 weeks). Many first-time builders underestimate the pre-construction timeline, which can easily stretch to 6 months in complex jurisdictions.

Site Work and Foundation (3 to 6 weeks): Clearing, grading, utility trenching, foundation excavation, forming, pouring, and curing. Weather is a significant factor here, as rain, snow, and frozen ground can delay foundation work by weeks.

Framing and Roof (4 to 8 weeks): Structural framing, sheathing, roofing, and window/door installation. This is typically the fastest-moving phase and the most visually dramatic. Once the structure is dried in (weather-tight), interior trades can begin regardless of weather.

Rough-In Systems (3 to 5 weeks): Plumbing, electrical, HVAC, and insulation work happens simultaneously or in rapid sequence. Coordination between trades is critical to avoid conflicts and rework.

Interior Finishes (6 to 10 weeks): Drywall, painting, flooring, cabinetry, countertops, fixtures, appliances, and trim. This phase has the most moving parts and the most potential for delays due to material availability, subcontractor scheduling, and change orders.

Exterior and Final (2 to 4 weeks): Exterior finishes, landscaping, driveway, walkways, final cleaning, and punch list items. Punch list work (correcting minor defects and completing small remaining items) often takes longer than expected.

Total Build Time: For a typical single-family home, expect 8 to 14 months from permit issuance to certificate of occupancy. Larger or more complex projects (custom homes, multi-unit, commercial) can take 12 to 24 months. Always add a 2 to 3 month buffer to your projected timeline when calculating financing costs.

Construction loans are typically structured for 12 to 18 months. If your project timeline is tight, discuss extension options with your lender upfront. Most lenders offer 3 to 6 month extensions for an additional fee (typically 0.5% to 1% of the loan amount per extension). Knowing the extension terms before you close prevents surprises if your project runs long.

The most successful construction investors build strong teams: experienced general contractors, reliable subcontractors, responsive architects, and knowledgeable lenders. A great team can compress timelines, catch problems early, and keep costs under control. Your lender should be an integral part of this team, providing fast draw processing and proactive communication throughout the project lifecycle.