Whether you’re looking to expand or starting from scratch, few businesses can afford to start a construction project on their own dime. That’s where commercial construction loans enter the picture. This post explains how these loans work and what to expect during the application process.
What Are Commercial Construction Loans?
Commercial construction loans help cover the cost to construct, renovate, or expand a building. Typically, these loans have shorter terms (i.e. the time allotted to pay back the amount borrowed) compared to personal loans or mortgages. They also usually charge a higher interest rate. The projected value of the completed project forms the basis of the loan.
How Do Commercial Construction Loans Work?
Commercial construction loans do not work the same way most loans do. For example, you don’t receive the full amount in one lump sum. Instead, the borrower and lender develop a draw schedule, or dates when the lender releases partial payments.
When are funds dispersed?
The draw schedule typically follows project milestones. For example, clearing and preparing the site, pouring the foundation, and erecting the frame are common milestones signifying the next draw release.
Upon completion of the milestone, the lender usually has an inspector confirm the work before it releases more funds. This pattern continues through the draw schedule and full distribution of the loan amount.
How do you pay back the loan?
As with other loans, the borrower pays interest on the loan amount. However, with commercial construction loans, you only pay interest on the amount released. Most construction loans also only require the borrower to pay the interest until the lender disperses the full amount. At the end of the project, the borrower becomes responsible for repaying the full amount of the loan.
If the borrower cannot pay the full amount, he or she can use the property as collateral to obtain a commercial mortgage. He or she uses those funds to repay the commercial construction loan. And the commercial mortgage typically offers a longer repayment schedule – 10 years or more – and more affordable payments.
Applying for a Commercial Construction Loan
There are numerous steps and requirements to apply for a commercial construction loan. The lender you choose reviews finances and credit scores for both you and your business. These are key factors in determining your loan’s interest rate and terms in the event you’re approved.
What does the lender want to know?
In a word: Everything. Construction loans are considered high-risk. Be prepared to give your lender detailed information regarding your business, including your industry, what you do, your financial records, current projects and operations, and your projections for the future.
The lender will also want to know all about the project you want financed. In addition to projected costs, you need to supply plan specs and designs, estimated payments to contractors, materials costs, and any other expenses you expect.
Even though the loan is for your business, expect the lender to also ask about your personal finances. He or she will want at least the following for both you and your business:
- Balance sheets
- Bank statements
- Debt schedules (including current debt obligations)
- Income statements
- Profit and loss statements
- Tax returns
Requirements vary by lender, so you may need to provide more documentation.
Most lenders require a credit score over 670. They’re also looking for a history of bankruptcy, foreclosure, and especially any previous defaults on construction loans. If you know there is negative information on your credit report, prepare an explanation. And really, you should pull copies of your credit report before beginning this process.
Expect the loan application process to take several weeks at least. You can help speed up the process by having your documentation ready and being available to answer follow-up questions.
Once you receive approval, the closing process begins. Review the loan agreement carefully, preferably with your company attorney. Once you approve, all that’s left is signing on the dotted line.
Do you have a commercial construction project? Doege Development provides a variety of commercial construction services. Call us at 623-242-5247 to learn more.