How Draw Schedules Work
Rather than funding the full construction loan amount at closing, lenders release money in a series of draws, each tied to a defined amount of completed, verified work. A typical draw request follows a schedule of values — the same line-item cost breakdown used to build the budget — and is supported by an inspection or a third-party construction consultant's report confirming the percentage of work actually completed for each line item.
Before releasing funds, the lender's title company generally issues a date-down endorsement confirming no new liens have attached to the property since the last draw, protecting the lender's first-lien position as construction proceeds. Lenders also commonly withhold retainage — a portion of each draw held back until the work, or the entire project, reaches completion.
Why Lenders Fund in Stages Rather Than All at Once
Staged funding limits the lender's exposure at every point in the project to roughly the value of work actually completed, rather than to funds that have been disbursed but not yet turned into physical progress. If a contractor defaults, a subcontractor walks off the job, or the project stalls for any reason, the lender's outstanding balance is tied to verified work in place rather than to promises about what the money would eventually build.
What an Interest Reserve Is and Why It Exists
A project under construction has no tenants and no operating income, so it has no natural source of cash to pay monthly loan interest. To solve this, construction loans typically include an interest reserve: a pool of loan proceeds, funded as part of the total loan amount, that the lender draws each month to cover accruing interest on the outstanding balance. That interest is capitalized — added to the loan balance — rather than billed to the borrower as an out-of-pocket payment.
This structure lets a project be built and stabilized without requiring the sponsor to service debt from equity during the exact period when the property is generating no income at all.
Sizing and Risks of the Interest Reserve
Lenders size the interest reserve based on the projected construction and lease-up timeline and the loan's interest rate, generally assuming the loan balance builds up gradually as draws are funded rather than sitting at the full amount from day one. Because the reserve is sized against an assumed schedule, a project that runs behind — due to weather, permitting delays, labor shortages, or scope changes — can burn through its interest reserve before the property is complete, at which point the sponsor may need to fund interest directly or negotiate additional reserve deposits with the lender.
Typical Steps in a Draw Request
- Contractor submits a draw request against the schedule of values
- Lender's inspector or construction consultant confirms percentage complete
- Title company confirms no new liens via a date-down endorsement
- Lender approves and disburses the draw, often net of retainage
- Retainage is released once the related work, or the project, is complete
Why Interest Reserves Matter
- Construction properties have no operating income to service debt
- Capitalizing interest avoids requiring the borrower to pay out of pocket
- The reserve is typically included within the total construction loan amount
- A reserve exhausted by delays becomes a real cash-flow problem for the sponsor
An Interest Reserve Can Run Out
Interest reserves are sized against an assumed construction timeline. If the project falls behind schedule, or draws faster than planned, the reserve can be depleted before the building is complete and generating income, leaving the sponsor to cover interest out of pocket or negotiate additional funding with the lender.
Module Check
Why do construction lenders fund loans through a series of draws rather than a single disbursement at closing?