When physicians get pre-approved for a construction loan, they focus on the loan amount: does it cover the cost to build? That's the right question. But it's not the only financial question that matters during a build. The two that catch most physician borrowers off guard are the draw schedule and the interest reserve — and they're not the same thing.
Understanding both before you sign a construction loan agreement can prevent some genuinely unpleasant surprises during what is already a stressful process.
What a Draw Schedule Actually Is
A construction loan doesn't fund all at once. Unlike a purchase mortgage — where the full amount is wired at closing — a construction loan releases money in installments called draws. Each draw corresponds to a defined stage of completion: foundation poured, framing complete, rough mechanicals (plumbing, HVAC, electrical), drywall, and final completion are common milestones, though every lender structures their draw schedule somewhat differently.
Before each draw is released, the lender typically sends an inspector to verify that the work billed for has actually been completed. The inspector produces a report; the lender approves the draw; funds are released, usually within a few business days. Your builder uses those funds to pay subcontractors, purchase materials, and continue the next phase.
This matters to you as the borrower for a few reasons. First, your builder's cash flow depends on draws arriving on schedule. Delays in draw processing — common when inspections back up or documentation is incomplete — can slow your project and create friction with your contractor. Second, draws are typically disbursed to the builder, not to you — meaning you're not holding a large sum; the lender and the title company manage the disbursements.
What to ask your lender: How many draws does your program allow? How long does draw processing typically take? Is there a cost per draw inspection?
Why the Number of Draws Matters
Lenders vary significantly in how many draws they allow. Some programs offer five or six standard milestone draws. Others, especially programs designed for physician borrowers building custom homes, allow 10 or more draws — which means your builder can get paid more frequently and manage cash flow with more flexibility.
Fewer draws isn't always bad, but it means your builder may need to front more of their own capital between disbursements. Some contractors build this into their pricing — effectively charging you more to compensate for the float. When you're comparing construction loan programs, the draw count and processing time are worth asking about explicitly, not just the interest rate.
Interest Reserves: The Loan That Pays for Itself
Here's the part that genuinely surprises most physician borrowers: during construction, you owe interest on every dollar that has been drawn — but the home you're building doesn't exist yet, you're likely still renting or living in your current home, and you have no rental income from the property. You're being charged interest on a building that isn't finished.
To handle this, most construction loan programs include an interest reserve — a portion of the loan set aside specifically to make the monthly interest payments during the construction period. Rather than requiring you to pay out of pocket each month, the lender draws from this reserve to cover interest as it accrues.
The size of the interest reserve depends on three variables: the loan amount, the interest rate, and how long construction is expected to take. On a $600,000 construction loan at 7.0% over a 12-month build, your rough interest reserve needs to be around $42,000 (that's approximate — actual interest grows as more draws are taken and the outstanding balance climbs). On a $1.2 million loan, you're looking at roughly $80,000–$90,000 in interest reserve.
That interest reserve comes out of your total loan amount. Which means your loan needs to be large enough to cover both construction costs AND the interest reserve — and both need to be accounted for in your loan-to-value calculations.
The Math Your Pre-Approval Might Not Reflect
Here's where things get tricky for physician borrowers who are accustomed to purchase mortgages.
When you're pre-approved for a construction loan, the approval is typically based on the "as-completed" appraised value — what the property will be worth when it's finished. Lenders will typically lend up to 80%–90% of that value, depending on the program.
But your total loan needs include both construction costs and the interest reserve. If those combined costs exceed the loan capacity based on appraised value, you'll need to bring more cash to the table — even if you thought you were putting down 10%.
A simplified example:
- As-completed appraised value: $1,000,000
- Lender will fund up to 85% LTV: $850,000
- Construction cost: $790,000
- Interest reserve needed (12 months at 7%): ~$50,000
- Total needed from the loan: $840,000
- Available from the lender: $850,000 — you're fine here, but barely
Change that construction cost to $825,000 and you have a shortfall. That shortfall comes from your down payment or cash reserves.
What Happens If the Build Runs Long
Interest reserves are sized for an expected construction timeline. If your build runs 14 months instead of 12, you'll exhaust your reserve and need to make interest payments out of pocket for the remaining period. On a $600,000 loan at 7%, that's about $3,500 per month. It's not catastrophic, but it's unbudgeted cash out during a period when you may already be stretched thin.
Better construction loan programs offer extensions and allow additional interest reserve amounts to be added if the project runs long, though this usually involves paperwork and sometimes a fee.
Key question for your lender: What happens if my build takes longer than expected? Can the interest reserve be extended, and what does that process look like?
The Practical Takeaway
Before you finalize your construction budget, build in these numbers explicitly:
Draw-related costs: inspection fees per draw (often $100–$300 each), title update fees per draw, and any lender processing fees. On a 10-draw project, those add up.
Interest reserve: budget based on your full loan amount, your expected rate, and your timeline — then add two months of buffer for delays. Talk to your lender about whether the reserve is built into the loan or funded separately.
Contingency: separate from the interest reserve, a 10%–15% construction contingency covers cost overruns in the underlying build (covered in our companion article on managing budget overruns).
The physicians who navigate construction loans most smoothly are the ones who come in treating the financial structure as carefully as they'd treat any other complex decision. The draw schedule and interest reserve aren't fine print — they're the engine that moves money from the bank to your builder. Understanding how they work puts you in control.
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MedPharmaConnect is an educational resource, not a lender or financial advisor. For guidance specific to your situation, consult a construction loan specialist or financial advisor experienced with medical professional borrowers.
MedPharmaConnect is an educational resource, not a lender. Always verify program details, current rates, and eligibility with licensed mortgage professionals.