How Do Ground-Up Construction Loans Work?
By Andrew J. Liersch III — Founder & CIO, Slingshot Investments. 10+ years in private lending, $500M+ funded. Former Wells Fargo Private Mortgage Banking, Bear Stearns, and Deloitte Consulting.
Short answer: A ground-up construction loan funds a new build in two pieces. At closing, the lender advances against the land — the purchase price if you’re buying the lot, or its appraised value if you already own it. The rest of the loan is a construction holdback: money set aside and released in draws as each phase of work is completed and inspected. Most private money construction loans also build in an interest reserve, so the loan carries its own payments during construction. Terms typically run 12–18 months, and the loan is sized against both your total project cost and the finished home’s value.
If you’ve read our article on how private money lenders underwrite a fix-and-flip loan, the logic will feel familiar — but ground-up deals have three moving parts a flip doesn’t: land, vertical construction from a dirt start, and a longer timeline. Here’s how each piece works.
What are the three components of a construction loan?
Every ground-up construction loan breaks into the same three buckets:
1. The land advance (funded at closing). If you’re purchasing the lot, the lender advances a percentage of the purchase price — commonly 50–60% of land value on private money terms, sometimes more when the lot is entitled with approved plans and permits. If you already own the land free and clear, its equity typically counts as your down payment, and many borrowers close with little additional cash in.
2. The construction holdback (released in draws). This is the vertical budget — foundation, framing, mechanical/electrical/plumbing, roof, finishes. It is not wired to you at closing. It sits in holdback and is released in stages as work completes, verified by inspection. Private money lenders commonly fund up to 100% of the vertical construction budget, provided the total loan stays inside the overall sizing caps below.
3. The interest reserve. Construction projects don’t generate income until they sell or refinance, so most construction loans set aside 6–12 months of interest payments inside the loan itself. Each month, the payment is drawn from the reserve rather than your bank account. It’s a real cost — you’re paying interest on the reserve too — but it protects your liquidity for cost overruns, which every build has.
How is a ground-up construction loan sized?
Two caps, and the loan is the lesser of the two — the same dual-cap logic used on fix-and-flip loans:
- Loan-to-Cost (LTC): typically 80–90% of total project cost (land + hard costs + soft costs) on private money terms.
- Completed-value LTV (LTARV): typically 65–70% of what the finished home will appraise for.
The completed-value cap is the construction equivalent of ARV on a flip — if you’re new to that concept, our guide to estimating ARV covers the comp-selection discipline, which applies identically to new construction (with the advantage that new-build comps are cleaner: no condition adjustments).
Two San Diego examples with real numbers
The same dual-cap math scales from a single spec home to a small apartment project. Here’s both.
Example 1: SFR spec build in Del Cerro
Say you’re building a 2,200 sq ft spec home on an entitled lot in Del Cerro:
| Line item | Amount |
|---|---|
| Lot purchase price | $350,000 |
| Vertical construction budget | $550,000 |
| Soft costs, permits, contingency | $100,000 |
| Total project cost | $1,000,000 |
| Projected completed value | $1,600,000 |
Cap 1 — LTC at 85%: $1,000,000 × 85% = $850,000 Cap 2 — Completed-value LTV at 70%: $1,600,000 × 70% = $1,120,000
The loan is the lesser: $850,000. At closing, roughly $200,000–$210,000 advances against the lot (about 60% of land), and the remaining ~$640,000–$650,000 funds the construction holdback and interest reserve, released in draws as the build progresses. Your cash in: about $150,000 plus closing costs — and if you already owned that lot outright, your land equity would cover most of it.
Example 2: 8-unit multifamily in Bankers Hill
Now a ground-up small multifamily on an entitled Bankers Hill lot — eight units, walkable to Balboa Park, the kind of infill project San Diego’s density incentives were written for:
| Line item | Amount |
|---|---|
| Lot purchase price | $1,200,000 |
| Vertical construction budget | $2,800,000 |
| Soft costs, permits, contingency | $500,000 |
| Total project cost | $4,500,000 |
| Projected completed value | $6,500,000 |
Cap 1 — LTC at 85%: $4,500,000 × 85% = $3,825,000 Cap 2 — Completed-value LTV at 70%: $6,500,000 × 70% = $4,550,000
The loan is the lesser: $3,825,000. At closing, roughly $700,000 advances against the lot, with the balance funding the vertical holdback and a larger interest reserve (multifamily builds run longer — plan on a 12-month reserve minimum). Borrower cash in: about $675,000 plus closing costs.
Two things change on the multifamily side. First, completed value is supported two ways — sale comps on a per-unit basis and the income approach off stabilized rents, and the appraisal will lean on whichever is more conservative. Second, the exit is usually a refinance rather than a sale: lease up the units, season the rents, and refinance into long-term rental financing. That makes your projected rents part of the underwriting file from day one, not an afterthought.
How do draws work on a construction loan?
The mechanics mirror a rehab draw schedule — we walk through the general process in What Is a Draw Schedule on a Rehab Loan? — but construction draws track build milestones rather than renovation line items. A typical five-draw schedule:
- Foundation — grading, footings, slab or stem walls complete
- Framing — structure framed, roof sheathed, windows set
- Rough MEP — mechanical, electrical, plumbing roughed in; rough inspections signed
- Drywall & exterior — insulation, drywall, stucco/siding, roofing complete
- Finishes & final — cabinets, flooring, fixtures, certificate of occupancy
Each draw follows the same rhythm: work completes → you request the draw → the lender’s inspector verifies → funds wire, usually within 24–72 hours on private money terms. Banks add layers (title updates, lien waivers per draw, longer inspection queues) that can stretch each draw to weeks — one of the main reasons experienced builders pay private money pricing.
Why do builders use private money instead of a bank for construction?
Three reasons come up on nearly every deal we see:
Speed to close. A bank construction loan commonly takes 60–90 days. Private money construction loans close in 2–3 weeks — and when a seller of an entitled lot has backup offers, that difference wins the deal. (More on closing timelines in How Fast Can You Close a Private Money Loan?)
Leverage on the vertical. Banks routinely cap total leverage at 65–75% LTC and want significant borrower cash in every phase. Private money lenders will fund up to 100% of construction costs inside the dual caps, which keeps builder capital free for the next lot.
Draw speed. During the build, slow draws are more expensive than a higher rate. If your framer finishes and the draw takes three weeks to fund, you’re paying interest on the full balance while the job site sits idle. Fast, inspection-based draws keep subs working and the timeline compressed — and on a construction loan, time is the real cost driver, the same dynamic we quantified for flips in What Does a Fix-and-Flip Loan Cost?
What do lenders require to approve a ground-up construction loan?
The core package: purchase contract or proof of land ownership, approved plans and permits (or a clear path to them), a line-item construction budget, your builder’s license and track record, and an exit — sale or refinance into a DSCR rental loan. Experience matters more on ground-up than on flips: most private money lenders want to see at least one comparable completed build, or a licensed GC on the project. We’ll break the full underwriting file down in an upcoming article on how private money lenders underwrite construction loans.
Frequently asked questions
Can I get a construction loan if I already own the land? Yes — and it’s the strongest position to be in. Land owned free and clear typically counts as equity toward your down payment, and many land-owned deals close with minimal additional cash from the borrower.
Do construction loans cover permits and soft costs? Generally yes — architecture, engineering, permits, and school/impact fees can be included in total project cost for LTC purposes, though policies vary by lender and by how far along entitlement is.
What happens if I go over budget? Cost overruns come out of your pocket — the holdback is capped at the approved budget. This is why experienced builders carry a 10% contingency line inside the budget and protect their liquidity with an interest reserve rather than paying interest out of pocket.
What’s the difference between a construction loan and a bridge loan? A bridge loan advances against a property’s current value with no holdback; a construction loan funds a build in stages. Some projects sit in between — a teardown-level rehab can be structured either way, which we’ll cover in a dedicated article on construction loans vs. fix-and-flip loans.
Slingshot Investments originates and arranges business-purpose ground-up construction loans on non-owner-occupied residential and commercial real estate. California DRE Broker License #02002790. Nationwide except AK, AZ, MN, ND, NV, OR, SD, VT. All loans subject to borrowers and underlying collateral meeting current underwriting criteria. Rates and terms subject to change without notice. This article is general information, not a loan commitment or financial advice.
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