Construction financing comes with its own vocabulary, and lenders tend to assume you already know it. If you’re piecing together how custom-build financing works for the first time, or trying to make sense of a term sheet a lender just sent over, this is the plain-language version of the terms that come up most often.
Quick answer: A construction loan is short-term financing that pays out in stages as a home gets built, rather than in one lump sum at closing. Most of the terms below describe either how that money is released or how the lender protects itself while the home doesn’t exist yet.
Terms About the Loan Itself
Construction-to-permanent loan
A single loan that covers both the build and the eventual mortgage, closing once and converting automatically into permanent financing when construction is finished. This is the structure most Bay Area custom-build buyers use, and it’s covered in detail in Construction-to-Permanent Loans Explained.
Draw
A portion of the loan released to pay for a specific stage of construction, rather than handing over the full loan amount at closing. Draws are the mechanism that keeps a construction loan tied to actual progress on the ground.
Draw schedule
The agreed-upon list of construction milestones, foundation, framing, roofing, and so on, that trigger each draw. Your builder and lender agree on this schedule before construction starts, and it’s what an inspector checks against before releasing funds.
Holdback
A percentage of each draw, often 10%, that the lender withholds until the project reaches a later milestone or final completion. It’s a safeguard against a builder walking away with funds mid-project.
Rate lock
Setting your interest rate at closing rather than letting it float until the loan converts to permanent financing. On a construction-to-permanent loan, this typically happens before a single draw goes out, removing the risk of rates moving against you during the build.
Interest-only period
The phase of a construction loan where you’re only paying interest on the funds actually drawn so far, not the full loan amount. This runs through the construction phase and ends once the loan converts to a standard amortizing mortgage.
Terms About Underwriting and Approval
As-built appraisal
An appraisal based on the home’s projected value once construction is complete, using the plans and specifications rather than an existing structure. This is how a lender sizes a construction loan against a home that doesn’t exist yet.
Contingency reserve
An amount set aside above the construction budget, usually 5 to 10%, to cover cost overruns. Lenders often require this on top of your stated budget, since construction costs move more than resale prices do.
Builder’s risk insurance
A policy covering the home during construction, before it’s finished enough to qualify for a standard homeowner’s policy. Lenders typically require proof of this before releasing the first draw.
VA minimum property requirements
A set of standards a finished home has to meet for VA-backed construction loans specifically, covering things like heating, water and sewage systems, and access. Veterans building with this benefit can find more detail in VA Construction Loans for Bay Area Veterans.
Terms About the Building Process
Change order
A formal, written change to the original project scope or budget, whether that’s a finish upgrade or a structural adjustment. Lenders usually need to approve change orders that affect the budget, since they were underwritten against the original plan.
Lien waiver
A document signed by a contractor or subcontractor confirming they’ve been paid for a completed stage of work and waiving their right to place a lien on the property for that amount. Lenders collect these at each draw to confirm the money already released actually reached the people who did the work.
Certificate of occupancy
The document a local building department issues once a home passes final inspection and is legally habitable. This is usually the trigger that converts a construction-to-permanent loan into your standard mortgage.
If you’re still working out where to build before any of this applies to you, it’s worth browsing available lots and homes while you get familiar with the financing terminology, so your site search and your loan conversation are moving on the same timeline.
Frequently Asked Questions
Why does a construction loan need its own vocabulary?
Why does a construction loan need its own vocabulary?
Because the lender is financing a project rather than a finished asset. Terms like draws, holdbacks, and as-built appraisals exist specifically to manage the risk of lending against something that isn’t built yet.
Do I need to memorize all of these before applying?
Do I need to memorize all of these before applying?
No, but recognizing them when a lender uses them saves time and helps you ask better questions during underwriting instead of after you’ve already signed.
Are these terms the same at every lender?
Are these terms the same at every lender?
The concepts are standard across construction lending, but specific requirements, like holdback percentages or contingency reserve minimums, vary by lender. Confirm the specifics with whoever you’re working with.
Where should I start if this is my first construction loan?
Where should I start if this is my first construction loan?
Get familiar with the draw schedule and contingency reserve first, since those two terms shape how the loan actually pays out and what you’re expected to cover if costs shift. Everything else in this glossary builds on those two concepts.
Build with Silicon Valley’s Custom Home Builder
Understanding the vocabulary makes the rest of the financing conversation easier. Talk to the AL Homes team about your project, or start browsing available lots and homes to see what’s realistic for your build.
