Standard mortgages fund finished, rentable buildings. When the plan is to build or gut-renovate, you need construction-style financing: money released in stages as work completes, at higher rates, with the lender looking over your shoulder the whole way.
How draws work
The lender approves a total budget, then releases funds in draws tied to completed milestones — foundation, framing, mechanicals, finishes. An inspector verifies each stage before money moves, typically within a week of the request. You front each phase (or your contractor does) and the draw reimburses it, so you need working capital even with the loan in place. Interest accrues only on funds drawn so far, usually interest-only during construction.
What it costs and requires
Construction and rehab loans commonly run 2–5% above standard mortgage rates, plus origination points and inspection fees. Lenders want a detailed budget and scope of work, a licensed contractor, and 10–20% of the project as your own cash. Terms are short — 6 to 18 months — with the expectation that you sell or refinance into permanent debt at completion.
The exit is the loan
Every construction loan ends with a balloon, so the exit must be underwritten before you start: either a sale (know your resale comps) or a refinance into a rental loan (know the as-completed appraised value and the DSCR the refinance lender needs). A "construction-to-permanent" product bakes the refinance in with one closing — often worth the slightly higher rate for the certainty.
Worked example
You buy a rough duplex for $180,000 and budget $70,000 of rehab. A rehab loan funds 80% of purchase plus 100% of rehab in draws: $214,000 total, 10.5% interest-only, 12-month term. Interest during an 8-month project on an average drawn balance of ~$180,000 runs about $12,600. As-completed value: $320,000; refinance at 70% LTV = $224,000 — enough to retire the loan and its costs.
When this rule of thumb breaks
Draw schedules assume the project runs on time; every month of delay adds interest and burns your term, and extensions cost points. Rehab budgets on old buildings routinely overrun — carry a 15–20% contingency or the last draw won't finish the job. And if credit tightens while you build, the refinance exit can vanish: lock the permanent lender's terms as early as they'll let you, and never start a project whose only exit is optimism.