How commercial construction loans are different
With a traditional loan, the entire amount amount being borrowed is given from the lender to the borrower in a lump sum to be paid back at interest over a fixed period of time. With a commercial construction loan, the lender gives money for each phase of the construction project at hand while making an inspection at each step to determine that the money is being used wisely. For example, a certain amount of money might be loaned out to prepare the construction site, then, if that goes well, another payment is given to complete the foundation of the building, and so on until the project is complete.
As the construction occurs, the borrower is only responsible for paying back the interest on each step of the loan. Once the project is complete, generally the borrower gets a mortgage where they can pay back the principle of the loan over time with the completed building as collateral, or they can pay it off in one lump sum if they have the money to do so. Commercial loans are given for renovations, expansions, buying land and pretty much any other type of construction or real estate project.
Interest rates and other costs to borrowers
A commercial construction loan is a high-risk type of loan, so interest rates are not always cheap. In fact, borrowers should expect to pay interest rates at between four and 12 percent, and the better the borrower’s credit rating, the lower the interest rate. Because there is a lot of oversight and processing required on the part of the lender, there are usually a number of fees associated with a commercial construction loan. These include project, fund control, inspection and documentation fees.
Another major expense associated with a commercial construction loan is the down payment, which takes some of the risk off of the lender. In general, the down payment is between ten and thirty percent of the project; it is rare for a lender to provide the money for all of the costs.
Not just any project will be green-lighted by a financial institution for a commercial construction loan. For starters, lenders look at an applicant’s credit score and are usually looking for a number at or above 600, depending on the circumstances of the application. The credit score of the business itself, if applicable, will also be used as a criteria. Furthermore, lenders want to see that the applicant has a low debt-to-income ratio, which is the relationship between how much money the business owes to how much it is taking in.
Lenders are very careful in determining eligibility. Applicants should be prepared to submit not only a detailed description of their business and its financial health but also of the proposed real estate development. It generally takes at least a few weeks to process a request, and supplemental documentation may be required during that time. In conclusion, taking on new real estate development is big step, but a commercial construction loan can make it happen.