Essential Dos and Don’ts for Construction Loans

by

Whether building or renovating a commercial structure, you will need sufficient funding. Land construction loans can help cover the costs. You can use them to buy land, purchase materials, and pay contractors.

Even if you have some savings, it’s still worth considering land construction loans because they offer several advantages. These CRE funding solutions often allow for interest-only payments during the construction phase to make it easier to manage your cash flow.

Remember that construction expenses don’t stop once the building is complete—you’ll need to factor in higher payments after the loan is refinanced (typically into a long-term mortgage).

Given these complexities, it’s essential to learn the basics of land construction loans before you apply. This blog will explore the “dos and don’ts” of obtaining this type of CRE financing.

Do understand your options.

There are generally two types of land construction loans:

  • Construction-only loans are short-term land construction loans designed to cover your project until completion. You’ll need to repay the entire loan balance after construction. If you can’t repay it by then, you might need to refinance or get a separate CRE loan.
  • Construction-to-permanent loans transition from a construction loan into a more traditional long-term financing arrangement once the building project is completed. During construction, you typically pay interest only on the funds drawn. After completion, the loan converts into a mortgage-style loan with regular principal and interest payments over a set term.

In many cases, CRE construction loans follow a draw schedule, meaning the money is released in stages (not as a lump sum). The private commercial lender will work with you to define specific milestones throughout the construction project.

You will get funds only after the lender verifies that you’ve completed a particular milestone. This strategy protects the lender’s investment while ensuring the project progresses as planned.

To find out all the costs.

Most commercial lenders will only finance part of the project. Instead, they only finance the loan-to-value or loan-to-cost ratio, which ranges from 70% to 90%. You must cover the rest of the project’s cost with a down payment.

Aside from the down payment, you also need to factor in the guarantee fees, project review fees, and processing fees when determining the costs of land construction loans.

Some lenders can integrate them into the loan, allowing you to pay them off over time instead of upfront. Depending on the lender, interest rates go from 4% to 12% or higher.

Don’t forget the appraisal.

Some lenders may request an appraisal to learn your property’s value and reduce their risk. Some may also ask you to shoulder the appraisal’s cost, which can range from $2,000 to $10,000. The price ultimately depends on your property’s size and the appraiser.

Don’t forget to explore other sources for construction loans.

Land construction loans are available from various sources—not just banks but also private commercial lenders (hard money lenders) and credit unions. Depending on your case, you might qualify for Small Business Administration (SBA) loans for construction purposes.

How do you know which lender to choose? Look for one that can provide the funds you need that are compatible with your requirements while also providing low fees and interest rates.

Banks and credit unions often have competitive terms but usually require excellent credit and several years of business experience. These strict eligibility criteria make them harder to qualify for.

You can also explore SBA loans. Provided by credit unions and banks, these loans are SBA-backed to reduce the lender’s risk.

Do understand what SBA 504 loans are.

To buy or renovate fixed assets using a land construction loan, look into the SBA 504/CDC loan program. These loans can provide up to $5 million and have 10, 20, or 25-year repayment terms. SBA 504 loans typically have the lowest interest rates.

Unlike typical construction loans, SBA 54 loans work like term loans. This means you will be asked to make fixed payments throughout the loan’s life instead of interest-only payments during the construction. That said, there might be exceptions, so ask the lender.

SBA 505 loans are only issued by Certified Development Companies in specific regions. You may refer to SBA’s website to find one near you.

Please don’t ignore the opportunity to get an SBA 7(a) loan.

An SBA 7(a) loan can also be used on construction projects. These loans function similarly to traditional construction loans—funds are disbursed in increments during the construction period.

You must pay only the interest on these disbursements until your construction project is completed. If you opt for this type of loan, ensure your lender provides clear and comprehensive information about the loan terms during the application process.

Don’t rule out a hard money lender.

Hard money lenders can be some of the best sources for land construction loans. Private commercial lenders can approve financing quickly—usually in just a few business days.

Their qualification requirements are often much less stringent than those of SBA lenders and banks. Do you have a less-than-stellar credit score? You might also have a better chance of securing a loan from these lenders. 

Do know the risks of hard money lending for construction projects.

Hard money loans might seem more straightforward to secure, but they are also more expensive because they are riskier for lenders. Some hard money loans have higher interest rates and shorter terms.

If you want the best deals, work with us here at Private Capital Investors. We offer the best interest rates and loan terms for construction projects.

To find out what your preferred lender requires.

Different lenders have different eligibility requirements, but in general, you have better chances of qualifying for land construction loans if you have the following:

  • A favorable debt service coverage ratio – Lenders use the DSCR formula to identify the ratio of your available money to your monthly debt obligations. They typically have a specific benchmark (they will disclose this to you during your application process).
  • Down payment – Prepare 10% and 30% of the overall purchase amount and have it on hand before applying for a loan.
  • Property appraisal – Most lenders will require an appraisal, which should be dated within 12 months of the loan application.

Don’t ignore the alternatives to construction loans.

If you’re renovating or buying existing property instead of building from the group up, you might not necessarily need a construction loan. There are other alternatives:

  • Commercial real estate loans – Also known as commercial mortgages, these loans can be used to buy a property that doesn’t require significant renovations. Like residential mortgages, they need a down payment (which also serves as collateral). The loan is then paid off over time.
  • SBA 504 loans—Need to renovate commercial property? SBA 504 loans can help. They offer extended repayment terms and low interest rates, making them good options for significant upgrades.
  • Business line of credit – This flexible financing option might be a good match if you plan to make minor, incremental improvements to an existing commercial property or need quicker access to funds than the SBA loan process allows. 

Benefits of commercial construction loans

Businesses and individuals looking to build a commercial property can benefit from land construction loans in the following ways:

  • Lower interest rates – Construction loans typically have lower interest rates than term loans, business lines of credit, and other commercial financing.
  • Tax-deductible – Interest paid on a land construction loan may be tax-deductible, minimizing the loan’s overall cost.
  • Customizable terms – Lenders often allow borrowers to customize terms, including the repayment schedule, loan amount, and interest rates.
  • Increased property value – Using a construction loan to build new commercial property can increase the property’s value. This can potentially boost resale value or rental rates.
  • More control over construction: Commercial construction loans offer more control over the building process, allowing borrowers to choose contractors and monitor the project’s progress.

She frequently asked questions on commercial construction loans.

Do you need help getting a commercial construction loan?

Due to their higher risk profile, commercial land construction loans are often more challenging to acquire than traditional loans.

Most lenders prefer borrowers with a good credit score and the capability to provide a 10% to 30% down payment. Plus, they may check the contractor’s background and track record.

What can I do with a commercial construction loan?

Funds from land construction loans can be used for different purposes related to constructing or renovating a building. These include land acquisition, covering the costs of permits, engineering and architectural costs, and contractor-related expenses.

Likewise, the loan can be used to prepare and develop a site, acquire building supplies and materials, or serve as a contingency reserve.

Are you interested in a commercial construction loan?

Look no further than Private Capital Investors for the best hard money solutions. We offer land construction loans and other funding options for various CRE projects.

Unlike banks, we are quick and efficient, so you won’t have to wait too long to get your funds. We finance properties from $2 million to $50 million and ensure approval within 48 hours. Call us at 972-865-6206 or email info@privatecapitalinvestors.com to get started.

Want to learn more? Get in touch with us today.

Similar Blog

What is Smart Building & Its Future in Commercial Real Estate

What is Smart Building & Its Future in Commercial Real Estate

If you’ve ever worked in an office, you’ve probably complained about the temperature at some point. Controlling the thermostat in large commercial buildings is tricky and is often a constant struggle. That’s because different building sections are affected by sunlight...

Want to learn more? Get in touch with us today.

Our experienced team is ready to assist with your financing needs.

Address:
2101 Cedar Springs Road Suite 1050 Dallas, TX 75201

Phone:
972-865-6206

Email:
info@privatecapitalinvestors.com