Construction Finance Guide

How a Construction Loan Works

Construction Loan

A short-term loan (typically 12–36 months, interest-only) that funds a project during the build itself. Unlike a standard mortgage, the full amount isn't disbursed at closing — it's drawn down in stages as work is completed and verified.

Draw Schedule

The agreed timetable of partial disbursements tied to construction milestones — e.g. foundation complete, framing complete, rough-ins complete. Before each draw, a lender-hired inspector typically confirms the claimed work actually happened on site.

Interest Reserve

A portion of the loan set aside specifically to cover interest payments during construction, since the project isn't generating income yet to service the debt itself.

Loan-to-Cost (LTC) vs. Loan-to-Value (LTV)

LTC measures the loan against total project cost (land + hard + soft costs) — the primary ratio lenders underwrite construction loans against. LTV measures it against the property's completed appraised value, the more familiar ratio from permanent mortgages.

Takeout Financing

The permanent (or longer-term) loan that pays off — 'takes out' — the construction loan once the building is complete, either a traditional permanent mortgage or, on a construction-to-permanent product, an automatic conversion of the same loan.

The Capital Stack

Senior Construction Debt

The primary construction loan, usually from a bank or specialty construction lender, secured by a first lien on the property — first to be repaid, and generally the largest single piece of a project's capital stack.

Mezzanine Debt

Financing that sits between senior debt and equity in the capital stack — higher-cost and higher-risk than senior debt, but repaid before equity holders, often used to reduce how much of a developer's own cash equity a project requires.

Preferred Equity

An equity investment with a fixed preferred return, paid before common equity holders but after all debt — functions similarly to mezzanine debt in the capital stack but is structured as equity, not a loan.

Hard Money / Bridge Loan

A short-term loan, typically asset-based rather than underwritten on borrower credit, used to move quickly (e.g. to close on a site) or bridge a gap before permanent or construction financing is in place — faster to close, at a materially higher rate than a bank construction loan.

JV (Joint Venture) Equity

An outside capital partner co-invests equity alongside the developer (the 'sponsor'), typically in exchange for a share of profits and some degree of control — how many ground-up NYC projects are actually capitalized above the debt layer.

Surety Bonds

Bid Bond

Submitted with a bid on a project, guaranteeing the contractor will honor its bid price and sign the contract if selected — protects the owner from a contractor walking away after winning.

Performance Bond

Guarantees the contractor will complete the project according to the contract terms. If the contractor defaults, the surety company steps in — typically by funding completion via a replacement contractor — up to the bond's face amount.

Payment Bond

Guarantees subcontractors and material suppliers get paid even if the general contractor fails to pay them — the mechanism that lets a sub recover from the surety instead of only the (possibly insolvent) GC. Almost always issued alongside a performance bond on public work.

Maintenance (Warranty) Bond

Covers defects in materials or workmanship discovered after completion, for a defined warranty period — a distinct, later-stage guarantee from the performance bond that covers the build itself.

Retainage, and New York's 5% Cap

Retainage is a percentage of each progress payment withheld until the work is substantially complete — standard practice across the industry as leverage to ensure a job actually finishes. Historically, New York owners could negotiate retainage well above 10% on private jobs. That changed with amendments to New York General Business Law §756-a and §756-c:

• Retainage on private construction contracts of $150,000 or more is capped at 5% of the contract sum — a contract clause requiring more is void.
• Retainage must be released within 30 days of final approval of the work.
• Late release accrues interest at 1% per month from the date it was due.
• A contractor may submit a final invoice upon substantial completion, as defined in the contract.

The cap took effect November 17, 2023 (S3539) and was tightened further by S5655, signed December 19, 2025, which voids — rather than merely discourages — any private-contract clause exceeding it.

Primary source: NY State Senate Bill S3539. Explainer: Holland & Knight, "New York's 5 Percent Retainage Law".