Quick overview

Short-term construction loans are short-duration loans that fund construction costs and typically convert to a permanent mortgage or are paid off at project completion. Borrowers draw funds in stages tied to project milestones rather than receiving the entire loan at closing. This staged approach limits lender exposure and helps builders get cash when they need it.

How draw schedules actually work

  • Establishing the schedule: The lender, borrower and builder agree on a draw schedule that breaks the project into milestone payments (e.g., site work, foundation, framing, rough‑ins, exterior finish, final). Each milestone has a budgeted amount and documentation requirements.
  • Requests and inspections: To trigger a draw, the builder submits a draw request with invoices, lien waivers, and photos. Lenders typically require an on‑site inspection or third‑party draw inspector before releasing funds.
  • Disbursement rules: Lenders pay the builder or the general contractor (or remit to an escrow) for costs already incurred. Many loans include retainage (commonly 5–10% of the draw) held back until project completion to cover punch‑list items.
  • Interest and fees: Interest is often charged only on amounts disbursed (interest reserve or interest‑only during construction). Rates may be variable and tied to indices; confirm timing and calculation with the lender.

Common draw schedule types and examples

  • Fixed‑milestone draws: Payments occur when clearly defined construction stages are complete.
  • Percentage‑complete draws: Disbursements based on percent of total work completed (used for larger or phased commercial projects).
  • Line‑of‑credit style (multi‑draw): Borrowers draw as needed up to a commitment limit with periodic inspections (see our guide on Multi‑Draw Construction Loan).

Builder protections lenders and owners should use

  • Retainage or holdback: A portion of each draw is withheld until satisfactory completion; this creates leverage to finish punch‑list items.
  • Conditional lien waivers: Require lien waivers tied to actual payment. Builders should insist on conditional waivers until funds clear to avoid inadvertent waiver of lien rights.
  • Progress inspections and certification: Independent inspectors or lender representatives verify completion before release.
  • Performance bonds and payment bonds: For commercial jobs, bonds protect owners and subcontractors against contractor default or non‑payment.
  • Clear change‑order process: Written, priced change orders approved by owner and lender before work proceeds to avoid funding disputes.
  • Insurance and builder risk coverage: Require builder’s risk, general liability, and workers’ compensation as conditions of funding.
  • Documented draw requisitions: Use standard requisition forms that list work completed, subcontractor invoices, and signed lien releases.

Avoiding the most common mistakes

  • Underbudgeting contingencies: Set aside at least 5–10% for unforeseen costs and schedule delays.
  • Weak lien‑waiver practices: Accept only conditional releases until the actual payment clears and maintain lien waiver logs.
  • Relying on verbal change orders: Always get written, signed change orders to ensure the lender will fund the extra work.
  • Skipping inspections: Never assume a draw will be released without proper inspection and paperwork; plan inspections into the schedule.

Practical steps for builders and borrowers

  1. Negotiate the draw schedule before closing and align payment dates with subcontractor payrolls.
  2. Ask the lender for a sample draw package checklist so you know exactly which documents trigger a disbursement.
  3. Maintain a single source of truth for invoices, photos, permits, and inspection reports.
  4. Consider a small interest reserve in the loan to cover interest‑only payments during construction.
  5. Use conditional lien waivers and keep originals of all paid invoices and releases.

When to involve professionals

  • Engage a construction attorney to review contract language (retainage, waiver forms, dispute clauses).
  • Use a qualified project manager or third‑party inspector for larger projects to speed draws and reduce disputes.
  • Talk to a mortgage advisor about conversion options (construction‑to‑permanent) and tax or amortization implications.

Resources and further reading

Professional disclaimer

This article is educational and based on practical experience in construction finance. It is not financial, legal, or tax advice. Consult your lender, attorney, or a certified financial planner for guidance tailored to your project.