What is a Construction Loan?
As we’ve said, a construction loan is a financial product designed for new build and/or renovation projections. In the world of business, commercial loans allow you to focus on a property intended for B2B or B2C uses. To put it another way, the property should be used for business. If you’re in the market for new construction loans, there are plenty of options out there.
An FHA construction loan is often touted as the best option for many small business owners due to the low-cost down payments. Of the FHA products available, the construction-to-permanent loan is often the first product business owners look at.
When you check out our recommended construction to permanent loan lenders, you’ll see that these products essentially contain two facets. The first stage covers the construction of a property and has a certain repayment rate (interest only). Once the property is complete, the loan converts to a monthly payment scheme like a traditional mortgage.
Because of this, construction to permanent loan rates can vary. During the initial stage, the rate might be higher because the risk to the lender is greater. Once it’s complete, the rate will fall.
If your aim is to build a property and sell it, you can opt for a construction only loan. These products don’t switch like a construction to permanent loan. Because you’re not looking to make repayments to clear the loan and build up equity in the property, you simply have to pay the interest.
In essence, your goal with an interest-only construction loan is to build a property, pay the interest while the loan is active and then clear it once you sell. The difference between the sale price and the loan amount (minus interest payments) is your profit.
Why Take Out A Commercial Construction Loan?
Commercial construction loans are one of the best ways to get a new base for your business. Regardless of whether you build a property or you renovate an existing one, the costs are high. As a small business, you probably won’t have the capital to fund such a venture.
However, without a new property, you might not be able to take your business to the next level. Commercial construction loans prevent a catch-22 situation.
Although commercial construction loan rates can be higher than standard business loans, they allow you to build or improve a property when you don’t have the available capital.
Therefore, if you’re looking to expand your business, commercial construction loans should be factored into your overall plan.
How a Construction Loan Works
Construction loans differ from traditional mortgages and loans in two main ways. Firstly, you won’t receive the full amount up front. Regardless of whether you apply for new home construction loans or their commercial counterparts, the money you get will be paid in installments.
Once you’ve been accepted for home building loans or commercial construction loans, you’ll agree a schedule with the lender that’s based on the project’s timetable.
When an agreement is in place, you’ll receive payments at set intervals. For example, before the foundations have been dug and then after. This leads to the second difference between construction loans and alternative funding options.
As we’ve said, interest rates can be higher. However, these products only offer interest-only repayments during the construction phase.
To help you manage costs, you only pay interest on the amount you’ve received. This actually makes construction loan interest rates more manageable for small businesses as the costs slowly increase as the project progresses.
Types of Construction Loans
To help you find the right type of building loan, we’ve listed some of the top products below. By using this information in conjunction with our recommended lenders, you should be able to get the best new construction loans for your business.
SBA CDC/504 Loan Program
This type of construction loan is offered by the Small Business Administration (SBA). When you apply to join the SBA CDC/504 Loan Program, you’ll be connected with a Certified Development Company (CDC). There are 260 of these in the US and they are designed to give small businesses fixed-rate, long-term financing for various projects.
As part of this program, you can get affordable construction to permanent loan deals.
SBA 7(a) Loan Program
The best construction loan lenders will almost always offer SBA 7(a) products. Also backed by the SBA, these loans allow you to borrow up to $5 million to purchase or build commercial real estate. Loan terms can be up to 25 years and down payments range between 10% and 20%.
If you receive a USDA construction loan or one of the many owner builder construction loans, the interest rate will be based on the prime rate plus up to 2.75%.
If you require more leverage, mezzanine lending could be an ideal option. With almost all loans, you (the borrower) have to put up some of the money yourself. If you don’t have the cash to do that, you can cover your stake with stock. If you default on a mezzanine loan, the lender will simply convert to an equity stake in your company. With mezzanine loans, you can achieve a loan-to-cost ratio of up to 95%.
As we’ve said, construction to permanent loan products give you money to build/renovate a property and then occupy it for business purposes. During the construction phases, construction to permanent loan rates are interest only. However, once the project is complete, the construction to perm loan switch to more of a standard mortgage with a monthly repayment plan.
Stand-Alone Construction Loans
A stand-alone construction loan is split into two separate loans. The first loan is obtained by the business and covers the cost of construction. The second loan is obtained by the individual and is used for debt (i.e. the first loan) accrued during construction. In essence, you start with a business loan and you clear it with a personal one.