What Is a Drawdown Loan?

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Written By SmarterrMoney.org

The latest in personal finance to help you make smarter money choices. 

A drawdown loan lets an issuer borrow more money “in chunks” with little added steps when they need more money to fund projects.

How drawdown loans can save municipalities money when financing projects

Municipal project construction can take years to complete and is often executed on an unpredictable schedule. 

When municipalities finance projects by issuing bonds, it can be inefficient to receive proceeds but wait until the project proceeds to spend all the proceeds.  In general, issuers lose money until bond proceeds are spent. 

One way to avoid the loss of money is to finance the project using a drawdown loan. This allows municipalities to take out money incrementally and quickly when needed during construction instead of taking all of the money at once.

A city might need $30 million total for a project. They could borrow the amount needed with bonds, but they’d have to invest any unused proceeds until needed for the project. They might earn a lower rate than their bond’s rate, losing money.
Instead, they could get a drawdown loan and borrow in $5 million chunks. This helps them minimize interest payments.

What’s important here?

The issuer will continue to increase the borrowed amount until finishing the project if a drawdown loan is needed. They also usually increase the loan over time with the interest payments they would have paid the bank. This eliminates any out-of-pocket interest expense they would have had to pay the bank. 

After completing projects, issuers can continue to keep the loan in place if they’d like. However, the loan rate usually increases after the construction period. Therefore, issuers usually refinance the loan with long-term bonds when a project is finished.