What is a Commercial Construction Loan?
A commercial construction loan is a loan used to finance any of the costs of building a commercial property, from the cost of the land or land development, to the cost of labor and materials. Commercial construction loans are usually large (minimum 1 – 3 million), and can either be short- or long-term. Typically, they’re given out by community or regional banks, who have a good understanding of the real estate market in a given area. Commercial construction can be risky for lenders, and borrowers will often have to put up 10% – 30% of the loan upfront, either as a down payment or collateral. Often, borrowers will use the land they plan to build on as collateral to guarantee the loan.
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Commercial construction loan interest rates average at 4% – 5%, though they can be higher depending on other details of the loan. In general, the smaller or shorter the loan, the higher the rates will be. Rates are also affected by how risky your lender considers the project to be, so the better your credit, or the more you can give as a down payment or collateral, the lower your lender will set the rates.
The approval process for commercial construction loans is similar to that of other commercial loans, meaning you’ll need a good credit score – generally, at least 660. And like with other commercial loans, you’ll need to provide thorough documentation. Except here it’s the details of the building plan that lenders will want to see, including estimated costs, and proof of a qualified and reputable builder.
Commercial construction loans can be long- or short-term. With short-term financing, you’ll receive all your funding before a certain point in the project. These can be used if you only need funding for part of the building costs. Say, for example, if you can cover the costs of the actual building itself, but will need a loan just to prepare the land to be built on, or vice versa. With long-term financing, you’ll start paying off the loan after the project is finished, meaning you might have your business up and running before you’ll need to start making payments, and it will be paid off over a long period of time, much like a regular mortgage. Another option is the mini-perm loan, which is basically a combination of the two, since it refinances the construction loan into something like a mortgage, but only has a moderate payment term.
Once approved for a commercial construction loan, you’ll receive portions of the loan (draws) at intervals throughout the construction process. How many draws, and when you’ll receive them, varies depending on what you agree to with the lender. Generally draws are scheduled according to certain stages in construction. It is also common that the first draw will actually come out of your down payment, so that it’s your own money that is at risk in the very beginning.
Finding the right lender to finance commercial construction can take time, but this is time well spent. Comparing different lenders, speaking with an expert, and doing as much research as you can before settling on anything will go a long way in making sure you’ve got the best borrowing option to get your business where you want it.