Construction Loan Math
As my beloved dad (who passed away two years ago this month) used to say, no one likes a financial surprise*.
The first two construction loan invoices I received were considerably less than I was anticipating. And while I am definitely less opposed to financial surprises that are in my favor, I like as much predictability as I can get in my budget. I decided to dig in a little deeper.
First, a recap: Our construction loan is through U.S. Bank. Like most construction loans, it is interest-only during the construction period. Because banks that offer construction loans generally want to be your only mortgage on a property, they extend a line of credit that covers both your existing mortage(s) plus the anticipated costs of construction. However, you only pay interest on the current balance, which grows over time as draws are made on the construction component of the loan.
Let’s say that you secured a loan for $1,850,000 at 5%. This total represents your existing $1,000,000 mortgage plus $850,000 in anticipated construction costs. Your loan closed on 12/28/22, but the bank didn’t actually fund the loan until 1/5/23. Your first payment is due on 2/1/23, and it will cover the 31 day period of 12/17/22 - 1/16/23.
The interest on the loan is calculated on a daily basis using the annual interest rate divided by 365 days in a year. Therefore, your first payment will look like this:
12/17/22 - 1/4/23: Technically, there is no loan balance during this time, so you owe no interest.
1/5/23 - 1/16/23: Once the loan funds, you begin paying interest on your existing mortgage of $1,000,000. The daily interest rate is 5%/365, or .000137 (I’m rounding here). For each of these twelve days, you owe $1,000,000 x .000137 = $136.99.
Your bill due 2/1/23 is $136.99 x 12 = $1,643.88
The next billing period ranges from 1/17/23 - 2/13/23 with payment due on 3/1/23. During this time, two draws are funded [note that there is generally a delay between when your contractor requests the funds and when funds are actually wired into the account; for the purpose of calculating the monthly interest payment due, we only care about the latter]. The first draw is for $50,000 on 1/17/23 and the second is for $65,000 on 2/8/23.
1/17/23 - 2/7/23: Your new balance is $1,050,000 (existing mortgage of $1,000,000 plus $50,000 draw). The daily interest rate for this 22-day period is $1,050,000 x .000137 = $143.84 x 22 = $3,164.48
2/8/23 - 2/13/23: With the second draw for $65,000, your balance increases to $1,115,000. The daily interest rate for this 6-day period is $1,115,000 x .000137 = $152.74 x 6 = $916.44
Your bill due 3/1/23 is $3,164.48 + $916.44 = $4,080.92
I can’t claim this is how all construction loans work, but it’s basically how mine works. I created a little calculator if you want to make a copy and play around with it.
One of the toughest parts about all of this is the variability of the timing and amounts of the construction draws. Initially, I assumed the draws would be more weighted toward the beginning of the project (lumber and concrete being among the pricier line items and all). So far, though, they have been once per month, so I forecast by taking the remaining construction balance and dividing it equally between the number of months left in the one-year construction period. It’s not perfect, but it’s good enough until I get hard numbers.
(*) My dad had a lot of little sayings that I plan to sprinkle throughout my posts for the rest of the month as a small tribute to a great father. I’ll bold them.
