On what amount does a borrower pay interest on a construction loan?

In a construction loan scenario, a borrower pays interest solely on the amount that has actually been disbursed for the project rather than on the total loan amount. Construction loans operate on a draw system, meaning funds are released in stages as the construction progresses. This allows borrowers to only incur interest on the money they are actively using for their construction costs at any given time.

This system is favorable for borrowers since it minimizes the interest expense, as they are not charged interest on the full loan amount from the outset. For example, if a construction loan has a total limit of $500,000 but only $100,000 is drawn during the first phase of construction, the borrower pays interest only on that $100,000, not the entire $500,000.

Considering the other options, none accurately reflect the nature of construction loans. Paying interest on the total loan amount or the estimated budget does not account for the incremental disbursement of funds. Additionally, the interest calculation based on the value of the property does not align with the borrower's actual loan payment obligations.