With a stage funding construction loan, the borrower only pays interest on the amount of money already disbursed. This means the borrower doesn't pay interest on money until they use it, unlike a Dutch interest loan. Stage funding can save borrowers money on interest — especially if the construction project takes a long time to complete.
For example, let's say a home builder takes out a $1 million hard money construction loan to build a high-end spec home. The purchase price of the lot is $500,000 and cost of construction is $800,000. Most hard money lenders will finance 40-50% of the land cost and 100% of construction costs. In this example, the lender is financing 40% of the land, or $200,000. Upon closing, the initial draw on the construction loan is only $200,000 with the first monthly payment $1,667/mo on a 10.00% note rate. Without any construction expenses, no interest is charged yet on the amount earmarked for construction.
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$1,000,000
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Construction Loan Amount
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$200,000
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Initial Draw
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$800,000
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Construction Financing (unused funds)
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10.000%
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Interest Rate
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$1,667
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First Payment (payment only on the $200K initial draw)
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When construction funds disburse for various stages of completion, such as foundation, framing and roofing, the subsequent monthly payments increase as the total loan amount increases.
Stage funding is advantageous as it saves a builder money on the overall debt service expense. This can be beneficial when projects are delayed, as we saw during the COVID-19 pandemic, when numerous construction projects were halted by labor and supply shortages. A construction loan with stage funding, as opposed to Dutch interest, reduces the overall project cost and increases the return on investment.