When a business wants to either build a new space or renovate an existing space, this is not covered by a commercial mortgage. Instead, that business will need to take out a different kind of loan that is known as a construction loan. This type of credit has some unique features that need to be considered by those who may be thinking of building for their business.
Construction is an expensive proposition for many business. These companies just simply do not have the cash on hand to cover the costs of building and renovation. Even if they did, construction costs can fluctuate wildly once construction has begun, Cost overruns may ultimately overtake the budget of even the deepest pocketed companies.
With that in mind, businesses will often seen construction loans when they need help financing their building project. This will ease some of the pressure and stress associated with paying for the builders and other associated costs while the project is progressing. When companies are paying these expenses out of their own pockets during the construction phase, every expenditure may involve a certain level of angst.
The defining feature of a construction loan is the manner in which the funds are disbursed to the borrower. In a traditional loan, such as a commercial mortgage, the funds are given the borrower all at once and upfront. The construction loan functions differently. Instead of giving all of the necessary funds upfront and at once, the loan is disbursed in phases based upon a pre-determined schedule that is agreed to at the outset of the loan. This schedule will be tied to various construction milestones. In other words, as these milestones are reached, an additional tranche of money is disbursed to the borrower. Of course, disbursement is not automatic, but is subject to an inspection after each milestone is reached.
The unique draw schedule has ramifications when it comes to the borrower’s interest payments. The borrower is not obligated to pay interest on the entire amount of the loan upfront. Instead, the interest liability comes as the proceeds are received. Borrowers cannot be expected to pay interest on monies that they have not yet received. Another feature of this loan is that borrowers will usually pay back the principal at the conclusion of the construction project in one lump sum. This type of loan has similar features to the interest-only type loans that are common in residential mortgages. Borrowers have the options of repaying the principal with the terms of a commercial mortgage once the project is completed.
There are a number of costs that are associated with a construction loan. The borrower will first have to make a down payment to the lender. This is to compensate the bank for the risk that it is taking in advancing the loan. Banks will calculate what percentage of the total project costs they are willing to loan the borrower. There are various fees that will need to be paid that will be disclosed at the outset.
There are several different types of construction loans that are available. Borrowers should do their homework to find the best terms and seek to work with those lenders who have experience and a sterling reputation. Once the borrower selects the appropriate lender, they can begin work on the application process. There are many steps in the application process, but the right lender will help a borrower work through all of these steps. Finding the right partner to work with will lessen the stress of applying for this loan.