Construction interest, sized like a lender.
A construction loan is never fully outstanding until the building is nearly done, so interest on it is not the rate times the loan. Enter the commitment, the rate, the construction period and anything funded at closing to see the interest the draws will actually carry, which is the number an interest reserve has to cover.
- Average outstanding balance
- —
- Monthly interest when fully drawn
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- Interest reserve to budget
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Assumes the balance not funded at closing is drawn in equal monthly amounts and interest is paid monthly on the balance outstanding. Real draw schedules are slower at the start and faster in the middle, and an interest reserve funded from the loan also carries interest on itself, so lenders add a cushion.
Why construction interest is not rate times loan
A permanent loan funds in full at closing and charges interest on the whole balance from day one. A construction loan funds in draws as work is completed and inspected, so the balance starts small and climbs toward the commitment. Interest is charged only on what has been drawn.
That is why the useful inputs are the draw pattern and the construction period, not just the rate. If the loan is drawn evenly, the average balance outstanding is a little over half the commitment, and interest during construction is roughly half of what a fully funded loan would cost over the same months. Most consumer construction calculators skip this and quote interest on the full amount, which overstates the cost and the reserve.
How the calculator works
Anything funded at closing, such as a land payoff or closing costs, is outstanding for the whole period. The rest of the commitment is drawn in equal amounts at the start of each month, and interest is paid monthly on the balance outstanding during that month. Interest during construction is the sum of those monthly charges.
The result is the size of the interest reserve a lender would ask for on those assumptions. The calculator also shows the average outstanding balance and the monthly interest once the loan is fully drawn, which is roughly the carry the project faces while it leases up.
| Output | What it answers |
|---|---|
| Interest during construction | How large the interest reserve in the budget needs to be |
| Average outstanding balance | How much of the commitment is really earning interest |
| Monthly interest when fully drawn | The carry during lease-up, before permanent financing |
A worked example
A $10,000,000 construction loan at 8 percent, drawn evenly over 12 months with nothing funded at closing, carries $433,333 of interest during construction. The average balance outstanding is $5,416,667, or about 54 percent of the commitment. A fully funded loan for the same year would cost $800,000.
Change the shape and the answer moves. The same $10,000,000 at 9 percent over 10 months, with $2,000,000 funded at closing for the land and $8,000,000 drawn evenly, carries $480,000 of interest. Once fully drawn, the loan costs $75,000 a month.
What lenders add on top of the estimate
Real draws are rarely even. Site work and foundations draw slowly, framing and systems draw fast, and the final draws wait on retainage and the punch list. An interest reserve funded from the loan also carries interest on itself. Lenders cover both with a cushion and require the loan to stay in balance, meaning the undrawn commitment plus remaining equity must cover the cost to complete, including the remaining reserve.
Each draw is approved against a construction draw schedule, an inspector's report, lien waivers and a title date-down. Prodeal runs that file for each draw as a checklist with owners and due dates, so the lender, the inspector and the borrower see the same open items.
Questions lenders ask
- How is interest calculated on a construction loan?
- Interest is charged only on the amount drawn, usually monthly. Because the balance grows as work is completed, interest over the construction period is roughly the rate times the average outstanding balance, not the full commitment. With even draws the average is a little over half the loan.
- How long is a construction loan?
- The construction period usually runs 12 to 36 months depending on the project, often with extension options. The loan is then repaid from a sale or refinanced into permanent financing, sometimes through a mini-perm period while the property leases up.
- What is an interest reserve on a construction loan?
- A budget line, usually funded from the loan itself, that pays interest during construction so the borrower does not pay it out of pocket. Its size is the estimated interest during construction plus a cushion, which is what this calculator estimates.
- What are the key differences between a construction loan and a mortgage?
- A construction loan funds in draws against inspected work, charges interest only on what is drawn, and is short term. A permanent mortgage funds in full at closing, usually amortizes, and runs for years. Construction loans also carry draw conditions, completion guaranties and in-balance requirements that a permanent loan does not.
- How much equity does a commercial construction loan need?
- It depends on the lender's loan-to-cost limit. A lender that lends up to a set share of total project cost expects the sponsor to fund the rest, usually before the first loan draw. The loan-to-cost calculator shows the equity a given limit implies.
- Loan-to-cost calculatorThe equity a construction loan requires.
- Interest reserve, definedWhat the reserve covers and how it is drawn.
- Construction draw, definedHow each draw is requested and approved.
- The construction loan closing checklistEverything due before the first draw.
- Construction loan managementRunning draws in one workspace.
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