All loans require you to learn the ins and outs of financing. Commercial construction loans are no different. Here is what you need to know about commercial financing to help you make smart decisions.
The Basics of Commercial Construction Loans
A commercial construction loan is a type of financing that borrowers use to build or renovate commercial real estate. The majority of commercial loan borrowers are business owners. Lenders structure the loans so borrowers receive the funds during the construction or renovation process. Borrowers pay back the loans in monthly installments over a set period of time. Construction loans typically have repayment terms of 10 years or more.
As construction reaches specific targets, lenders will release funds to borrowers. For example, lenders may release funds when contractors pour the foundation or finish framing the interior or exterior walls. A unique feature is borrowers only pay interest on the money lenders release until construction or renovation is complete. There are three types of construction loans lenders offer:
• Construction-to-Permanent- If there is a clear construction plan in place, lenders will release funds from the loan using a timeline. After construction is complete, borrowers can convert this loan into a traditional commercial mortgage.
• Renovation Loans- These loans are common among borrowers who buy commercial properties in need of renovations.
• Construction Only- This loan type requires two separate transactions. First, borrowers take out a loan to complete construction on a commercial property. Second, upon completion of the construction, borrowers must find a second loan to pay off the principal on the first loan.
Interest Rates/Fees/Down Payment
Commercial construction loans have interest rates, fees and down payment requirements just like any other loan. Here is a breakdown of the fees and interest rates you can expect to pay for commercial construction loans:
• Interest Rates- Rates on these loans are typically higher than traditional mortgages. Rates can range from 4 to 12 percent depending on your credit score and other factors.
• Fees- How much a commercial construction loan costs you varies by lenders. However, typical fees include processing fees, documentation fees, project review fees and guarantee fees.
• Down Payment- Lenders consider construction loans high-risk, so they usually require a significant down payment. In most cases, lenders require a down payment of 10 to 30 percent of the overall cost of the project. There are very few instances where lenders finance 100 percent of construction.
Qualifying for a Commercial Construction Loan
Commercial construction loan requirements are much more stringent than traditional mortgages. If you have a marginal credit score and gaps in your income, chances are good you will not qualify for a construction loan.
The typical minimum credit score requirement is in the mid-to-high 600s. However, some lenders require scores in the 700s. If you own a business, lenders will evaluate your business credit. You also need a low debt-to-income ratio. Lenders will require detailed information about the property, and you must prove you have enough savings to cover any additional costs.
The Bottom Line on Commercial Construction Loans
If your business is ready for expansion, a commercial construction loan is a good option. Although it can be a challenge to qualify for a loan, it is not impossible. If you perform some due-diligence on what to expect from commercial construction loans, you will have a better chance of finding a lender willing to finance your expansion.