The Basics of Construction Loans
If you are starting or expanding your business, you will probably need a commercial construction loan. Different from commercial mortgages, which are used to buy existing properties, construction loans are used to pay for labor and materials to build new structures or renovate commercial properties. They can also be used for land development purposes, such as clearing of vegetation, leveling or grading.
There are several key differences between commercial mortgages and construction loans. First, the funds of a construction loan are not disbursed all at once. The borrower and the lender will work together to outline a plan for fund disbursal, known as a draw schedule. At certain stages in the construction process, more funds will be disbursed. For example, the first draw may be to prepare the building site, the next when the foundation is complete, the next when the building is framed, and so on. Upon completion of each stage, an inspection is usually required before the next amount is disbursed.
Second, the borrower will only pay interest on the loan during the construction process, and at the end of project, the loan is repaid in one lump sum. In order to do this, a mortgage is usually obtained using the new property as collateral.
Finally, there are various fees involved in construction loans, including guarantee, project review and fund control fees. Guarantee fees are associated with the various guarantees required by a lender, such as a completion guarantee, which states that the project will be completed on time and within the planned budget. Project review fees cover the costs of planning and review documentation, which may include site assessment, building permits, code compliance assessment and proof of insurance for contractors. Fund control fees may be required if a third party is used to verify project documents and provide an intermediary between the lender and the borrower.
As with traditional commercial loans, a borrower’s credit score is a primary metric for deciding interest rates on construction loans — a higher credit score generally yields a lower interest rate. A borrower may obtain a construction loan through a bank or a private lender. A bank loan will typically have a lower interest rate but may take a longer time to get approved, while a loan through a private lender will usually have a higher interest rate but a faster approval time.
Whether you are upgrading, renovating, or building new office space, construction loans provide the capital to start or grow your business.