Construction in the U.S. is a multi-billion dollar business, and most businesses have to get a commercial construction loan to fund their project. To get approved for a loan, the borrower must have a business plan that the lender approves.
What’s a Commercial Construction Loan?
A commercial construction loan is obtained to finance the costs of construction or renovation on a commercial building. The loan can be used for:
- Labor and materials for new construction properties
- Purchasing and developing land for a new construction property
- Renovations of existing commercial properties
Why Take out a Commercial Construction Loan
A business owner usually needs to take out a loan because the costs associated with new construction and renovations can be expensive. A growing business usually doesn’t have that much money to spend without getting a loan.
How Commercial Construction Loans Work
The full amount of the loan isn’t paid at once. It’s paid when the project achieves milestones. The borrower will make a plan with the lender to determine when installments of the loan will be paid. Usually, after a milestone is completed, the lender will require an inspector to confirm that the work is completed before they give the borrower the next installment.
A borrower may have to pay interest on the portion of the loan that has been received, but most lenders will allow a borrower to start paying interest after the loan has been fully dispersed.
If the borrower doesn’t want to pay the loan after it’s been fully dispersed, they can receive a commercial mortgage. The property will be considered collateral, and the borrower will use the funds from the commercial loan to pay the mortgage.
Unfortunately, not all construction projects will be eligible for a loan. A lender will determine eligibility based on several factors.
The first thing a lender will look at is the borrower’s credit score. Usually, a lender will be more willing to work with someone who has a high credit score compared to someone who has a lower credit score. Before applying for a loan, a borrower should have a credit score in the 700 hundreds. Also, business credit scores will be evaluated.
When an application is submitted, the borrower requesting the loan will be required to provide details of the construction project. They’ll have to submit details about the builder, a detailed project timeline, the floor plan, construction drawings and the cost of materials and labor. Also, they’ll be asked to provide the loan amount they’re requesting.
A borrower can expect to pay between four to 12 percent interest on a commercial construction loan. A borrower who has a better credit score won’t have to pay as much interest. A loan from a bank will have the lowest interest rates.
There are fees associated with commercial construction loans. The fees that may have to be paid vary depending on the lender. A borrower may have to pay processing, guarantee, documentation, project review or fund control fees.
Usually, a down payment is required for commercial construction loans because there are so many risks involved. A 10 to 30 percent down payment is typical. A lender very rarely funds 100 percent of the project.
Before getting a commercial construction loan, make sure that the lender has experience. Ask the lender about previous construction projects they’ve financed. If the borrower has a good business relationship with a local banker or financial institution, they should contact them first.