Construction Loan Guide – Home and Commercial Loans

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.

Construction-to-Permanent Loan

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.

Construction-Only Loan

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%.

Mezzanine Loans

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%.

Construction-To-Perm Loans

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.

How Can I Get a Home Construction Loan?

How do you get construction finance? As with any type of finance, a commercial or house building loan will be offered on merit. In other words, you have to prove you’re a worthy borrower not only to receive a loan but to get the best rates.

In general, if you’re applying for a construction to permanent loan or any similar products, you’ll need to provide the following information:
h3 Debt-to-Income Ratio

This is how much money you owe and the money you make.

Credit Score

Lenders will look at your credit score as well as the financial state of your business. In general, you’ll need a score of 600 or greater in order to get most construction loans.

Down Payment

In addition to background checks, anyone wanting a construction loan will have to make a down payment. Because the lender either has no asset or one that’s in need of repair as insurance, the risks are higher. Therefore, you’ll need to make a down payment of between 10% and 30% of the total project cost.

Repayment Plan

Finally, you will need to agree both a payment schedule and a repayment plan. These will be based on the construction timetable and the type of financial product you receive.

What if I Don’t Qualify?

What happens if you found some commercial construction loans that suit your business but the lenders reject you? As we’ve said, construction loan interest rates and down payments can be high because these are risky propositions. Therefore, you need a solid financial history to get a deal.

Fortunately, even if you’re unsuccessful, there are many types of new construction loans out there. Mezzanine loans might be available, simply because the lender can get a stack in your company as insurance.

Special Considerations for Construction Loans

Regardless of whether it’s a commercial venture or a personal one, you need to make sure construction loans are right for you. As we’ve said, there are various types of construction loans available and each one has its own nuances in terms of repayments and rates. However, you also need to take into account some general factors.

For example, a first time home buyer construction loan can be difficult to obtain if you don’t have a large of amount of liquid capital. This is because the lender doesn’t have any insurance in the form of another property.

Basically, you need to assess construction loan terms before you apply. In general, the factors you need to consider are:

Down Payment: You may need to cover up to 30% of the project’s total cost.

Rates: Repayments are usually interest-only and often have a premium above the prime rate.

Credit History: Due to the lack of collateral, you’ll need a strong financial history to prove you’re a responsible borrower.

Construction Loans vs. Owner-Builder Construction Loans

Before we conclude this look at construction loan rates, types and options, it’s important to distinguish between owners and non-owners. In the world of home construction loans, you can either be removed from the building process or in charge of it. If you’re removed, you’ll need a standard construction loan. These are given to an individual or company on the basis they use a general contractor to carry out the work required.

In contrast, owner builder construction loans are given to landowners that act as their own general contractor. With owner builder loans, you take on more responsibility and must have experience handling large projects. In some instances, owner-builder construction loans can be seen as a greater risk than standard construction loans.
Construction Loans With Bad Credit

A credit score of 600+ (580 as a minimum) is usually required for this type of loan. The good news, however, is that there are home builders that work with bad credit borrowers. If your financial history is poor, you can try to improve it before you apply.

Failing that, a bad credit construction loan can be obtained in certain circumstances if you put down a larger down payment. Finally, if a bad credit construction loan isn’t an option, some construction companies are large enough that they can finance themselves. If you can secure a deal with these, it may be easier than working with a financial agency.

Final Thoughts

If you’re looking to build a new home or renovate a property for your business, a construction loan is perfect. Designed to bridge a financial gap and help you turn nothing into something, commercial and home construction loans are a great source of funding.

As long as you meet the lending criteria, understand how construction loan rates work and can afford the repayments, there’s no reason you can’t apply. Indeed, by checking out our list of recommended lenders, you can find the best new construction loans and, hopefully, secure a deal that works for you.