How Do Construction Loan Disbursements Work? Complete Draw Schedule Guide
Construction loan disbursements operate differently than traditional mortgage funding. Rather than receiving the entire loan amount at closing, construction loans release funds incrementally through a structured draw schedule tied to specific building milestones. Understanding this disbursement process is essential for anyone planning to build a home or investment property.
Understanding the Basics of Construction Loan Disbursements
Unlike conventional mortgages where you receive full funding at closing, construction loans disburse money in phases called "draws." Each draw corresponds to a completed construction milestone and requires verification before funds are released. This milestone-based approach protects both the lender and borrower by ensuring money flows only as work is actually completed.
The disbursement process involves several key parties working together: the borrower, the lender, the general contractor, and typically a third-party inspector. Each plays a crucial role in ensuring funds flow smoothly while maintaining proper oversight of the construction project.
Why Lenders Use Draw Schedules
Lenders don't release construction funds all at once for several important reasons:
Risk Management:
- Ensures funds match actual work completed
- Prevents overpayment for unfinished work
- Protects against contractor default or abandonment
- Maintains collateral value throughout construction
Quality Control:
- Required inspections verify workmanship standards
- Building code compliance is confirmed at each stage
- Plans and specifications are being followed correctly
- Problems are identified early before they compound
The Draw Schedule: Your Construction Funding Roadmap
A draw schedule is a predetermined plan outlining when and how much money will be released at each construction phase. This schedule becomes part of your loan agreement before closing and typically follows a standard milestone structure.
Standard 5-6 Draw Schedule
Draw 1: Foundation (15-20% of loan) Covers site clearing, excavation, foundation footings and walls, concrete slab or basement floor, and underground plumbing. This first disbursement is often the largest single draw due to expensive materials like concrete and rebar, plus specialized labor requirements.
Draw 2: Framing and Roof (20-25% of loan) Funds wall framing and structural elements, roof trusses and sheathing, window and exterior door installation, and weather barrier application. This milestone represents "dried-in" status when the structure is protected from weather - a major project milestone.
Draw 3: Mechanical Rough-In (15-20% of loan) Covers electrical wiring and panel installation, plumbing supply and drain lines, HVAC ductwork and equipment, and specialty systems like low-voltage wiring. Rough-in work must pass inspection before walls are closed, making this a critical quality checkpoint.
Draw 4: Interior Finish Work (15-20% of loan) Includes insulation installation, drywall hanging and finishing, interior painting, trim and molding, and cabinet installation. This phase transforms the structure into a recognizable home.
Draw 5: Final Finishes (10-15% of loan) Covers flooring installation, fixture installation, appliances, countertops, and final paint touch-ups.
Final Draw: Completion (5-10% of loan) Requires certificate of occupancy, all final inspections passed, punch list items completed, final lien waivers from all contractors, and release of retainage holdback.
For complex projects involving both site work and building construction, you may need financing that covers horizontal construction and site development in addition to vertical construction financing.
The Draw Request Process: Step by Step
Understanding exactly how to request and receive each draw helps ensure smooth funding throughout your project.
Step 1: Milestone Completion
Your general contractor completes the work associated with the next draw milestone. Documentation of completed work typically includes progress photos, subcontractor invoices, material receipts, and updated project timeline.
Step 2: Draw Request Submission
Either you or your contractor submits a formal draw request to the lender. Required documentation typically includes completed draw request form, current invoices from contractor, lien waivers from previous draw recipients, updated budget showing costs versus projections, and progress photos.
Lien Waivers Are Critical: Before disbursing funds, lenders require lien waivers from contractors and subcontractors who were paid with the previous draw. These documents confirm payment was received and waive the right to file a mechanics lien against the property. Missing lien waivers are a common cause of disbursement delays.
Step 3: Inspection Scheduling
Upon receiving your draw request, the lender orders an inspection. Most lenders use third-party inspection services to maintain objectivity. The inspection fee ($100-$250 per inspection) is typically charged to the borrower.
Step 4: On-Site Inspection
The inspector visits the property to verify that work described in the draw request is complete, quality meets acceptable standards, construction matches approved plans, building codes are being followed, and overall percentage of completion is accurate. The inspector creates a detailed report with photos documenting current project status.
Step 5: Approval and Disbursement
The lender reviews the inspection report and compares it against the original construction budget, draw schedule percentages, any change orders, and previous disbursements. Upon approval, funds are released according to your loan's disbursement method.
Understanding Retainage and Holdbacks
Retainage (also called holdback) is a percentage of each draw - typically 5-10% - that lenders withhold until project completion. For a $400,000 construction loan with 10% retainage, $40,000 remains undisbursed until final completion.
Purpose of Retainage
Retainage protects against incomplete punch list items, undiscovered defects, unpaid subcontractors filing liens, contractor abandonment late in the project, and final inspection failures.
Releasing Retainage
To receive your retainage, you must provide certificate of occupancy, final inspection approval, all lien waivers (conditional and unconditional), completed punch list verification, and a final title search showing no liens filed against the property.
Use our commercial mortgage calculator to understand how disbursement timing affects your interest costs throughout the construction period.
Disbursement Methods: Which Is Right for Your Project?
Lenders offer different approaches to releasing construction funds. Understanding these methods helps you choose the best fit.
Direct Disbursement to Contractor
Funds are sent directly to your general contractor, who manages all payments to subcontractors. This method works best for experienced, reputable builders with whom you have established relationships. It requires strong trust in your contractor and provides less oversight of fund distribution.
Controlled Disbursement (Voucher System)
A title company or escrow agent manages disbursements, paying each vendor directly after collecting lien waivers. This method is ideal for owner-builder projects and situations requiring maximum lien protection. While it involves more administrative paperwork and slightly longer processing times, it provides maximum protection against mechanics liens.
Two-Party Check System
Checks are made payable to both borrower and contractor, requiring both signatures before deposit. This provides a balance of oversight and flexibility without full escrow administration.
Common Disbursement Challenges and Solutions
Inspection Reveals Incomplete Work
If the inspector reports work is only 80% complete but the contractor requested the full draw amount, the lender approves proportional disbursement. Remaining funds are released when work is verified complete, which may require a follow-up inspection.
Missing Lien Waivers
Subcontractors must provide lien waivers from the previous draw before current disbursement proceeds. Establish clear lien waiver procedures upfront and make waiver submission a condition of payment to prevent delays.
Budget Overruns
When actual costs exceed the original budget, document cost increases with formal change orders, request loan modification if possible, or provide additional borrower funds. Build 10-15% contingency into your original budget to avoid this situation.
Contractor Cash Flow Issues
If contractors request early draws or advance payments outside normal schedule, stick to the established draw schedule and only pay for completed, verified work. Contact our construction loan specialists if contractor pressure becomes concerning.
Interest Charges and Disbursements
Construction loan interest is calculated only on disbursed funds, making draw management an important cost factor:
- Month 1: $80,000 disbursed = ~$500/month interest (at 7.5%)
- Month 3: $200,000 disbursed = ~$1,250/month interest
- Month 6: $350,000 disbursed = ~$2,187/month interest
- Month 12: $400,000 disbursed = ~$2,500/month interest
Minimizing Interest Costs
Request only funds needed for completed work - avoid pulling funds "just in case" since each extra dollar disbursed costs interest. Time draws efficiently to balance contractor needs with interest costs. Complete your project on schedule since every extra month extends your interest-only period.
Draw Request Timeline
Typical disbursement from request to funds takes 7-10 business days:
| Step | Typical Timeframe |
|---|---|
| Draw request submitted | Day 1 |
| Lender reviews request | Day 1-2 |
| Inspection ordered | Day 2-3 |
| Inspection conducted | Day 3-5 |
| Report submitted and reviewed | Day 5-7 |
| Funds released | Day 7-10 |
Factor this timeline into your project planning so contractors can sequence work to maintain continuous progress between draws.
Working With Your Construction Team
Before construction begins, discuss with your contractor:
- Your specific draw schedule and milestones
- Documentation requirements for each draw
- Lien waiver procedures and timing
- Inspection process and typical timelines
- Payment timing after fund receipt
Maintain regular communication about upcoming milestone completions, budget or timeline changes, and documentation needs. When problems arise, address documentation gaps promptly, communicate with your lender proactively, and don't let small issues become large problems. Contact our construction loan specialists for guidance if disbursement issues occur.
Your Next Steps
Understanding how construction loan disbursements work prepares you for a successful building project. The draw process follows a logical pattern designed to protect everyone involved while ensuring your project gets needed funding.
Ready to move forward with your construction project? Here's what to do:
- Learn About Draw Schedules: Understand your lender's specific milestone requirements
- Choose the Right Contractor: Select a builder familiar with construction loan processes
- Establish Documentation Systems: Set up tracking for all draw-related paperwork
- Plan for Inspection Timing: Build draw timelines into your project schedule
- Build Cash Reserves: Set aside funds for potential delays or overruns
- Apply for your construction loan: Get started with experienced construction lenders who make disbursements smooth
Final Thoughts
Construction loan disbursements work through a structured draw process that releases funds as your project reaches specific milestones. Each draw requires completion verification through inspection, proper documentation including lien waivers, and lender approval before funds are released.
The key to smooth disbursements lies in understanding the process, maintaining excellent documentation, and communicating effectively with your contractor and lender. While milestone-based funding requires more involvement than traditional mortgage funding, it protects your investment by ensuring money flows only as actual construction progress is made.
Whether you're building a custom home or developing an investment property, mastering the disbursement process helps your project stay on budget and on schedule. With proper planning and the right lending partner, construction loan draws become routine checkpoints rather than stressful obstacles.
Have questions about construction loan disbursements for your specific project? Speak with our experienced team today for personalized guidance on navigating the draw process successfully.