According to Construction Executive magazine’s national study, approximately 9 out of 10 commercial contractors experience recurring cash flow problems. And when these contractors need financing for their commercial construction projects, researchers warn that most traditional banks and institutions are wary of offering a contractor a loan due to the inherent financial risks involved in commercial construction.
Learn how to navigate the construction loan process, and be prepared in advance for what your lender will require of you. Not only will this improve your odds of getting the funding you need, but it can also help you to find the right type of funding — including construction supplies-specific financing — to grow your business and obtain peace of mind.
How Do You Qualify for a Construction Loan?
For financial institutions and traditional lenders, financing a construction project is risky. Contractors are faced with a high upfront cost that will only return economic benefits over a long-term timeline. Many contractors also need bridge financing (funds to fill the gap between making expenditures, such as buying materials and supplies and obtaining revenues), which increases the risks for banks.
The above factors mean that qualifying for a construction loan is often far more complex and requires far more steps and documentation than personal financing.
Down Payment
Due to the higher risk of construction financing, most lenders will require a significant equity contribution or a high down payment. You can expect to need a minimum down payment of 20%. However, this amount may be much higher depending on factors like the project’s scope, the total amount of financing needed, the location of your project, etc.
In most cases, the down payment must cover the property costs (where applicable) and cover your costs up to the first draw of funds.
Strong Personal Credit History
All forms of financing require documentation showing that you’ve always repaid your loans on time. This is also true with commercial construction.
All lenders will want to see your business’ credit history, as well as your personal credit history so that they have the confidence that you’ll meet your obligations as outlined in your repayment agreement.
Financial Documents
Financial institutions and banks will expect that your construction company is on a stable financial footing and that it’s generating a profit. This helps give the lender confidence that you’ll complete the construction project and have the ability to pay them back.
The lender will want to closely examine your current debt load, your past financial documents and statements, all proof of assets you own, and your tax returns (typically three years’ worth of returns).
Detailed Plan If The Loan Will Be Approved
Lenders want to know that your project is set up for success and that your strategic plan accurately estimates your financial commitments. Financial institutions will need access to your operational documents, including your business plan, financial projections, building plans, contractor/subcontractor bids, and any existing or upcoming construction contracts.
Good Reputation
While a company’s standing in the broader community is a bit ethereal and harder to quantify, most banks and lenders want to know they’re working with someone who is reputable. Your past and current reputation is a good indicator of your future performance.
They’ll specifically want research on the building company and any partners you may be working with. This may include vendor reviews, subcontractor reviews, online client reviews, documentation and reports from previous construction projects, and more.
Appraisal
Unless you’re working with an alternative lender or non-traditional financing, most banks and institutions will have a maximum loan-to-value amount of 75% of the purchased price or the appraised value.
The lender will work with a pre-approved appraiser to analyze your commercial construction project and estimate its future value.
Steps Toward Construction Financing
Every lender has its unique processes and construction loan requirements. However, the application process to get a commercial construction loan tends to follow a standard, streamlined general steps series.
1. Have Your Initial Discussion
The lender will want to know your overarching needs and parameters, including general information about the project, the timeline and budget, and your own estimates on how much financing you require.
Keep in mind that this isn’t the deep dive into documentation reviews and appraisals. Instead, it’s the starting dialogue between you and the lender to find a financing solution and lending product that works best for your project parameters.
2. Apply for Financing
Many lenders require you to apply for financing in person, but more modern institutions offer the convenience and accessibility of online applications.
After you submit your application, the lender will review your information and send you initial loan disclosures that inform you of the commercial construction loan terms, including all fees and other financing costs. At this time, the bank will also provide you with a list of all supporting documents that it needs to review and approve your loan.
3. Submit Your Contract
Once you have finalized your builder’s contracts, you must submit them to your financial institution. This is a critical step for loan underwriting.
4. Complete the Loan Underwriting
Loan underwriting is the financial terminology used to describe the credit checks and documentation review required.
This process can be pretty lengthy. The bank’s team will review all of the documentation you provide and likely have follow-up requests, questions, and clarification items.
5. Get an Appraisal
The financial institution will work with an approved appraiser to get an accurate assessment of your project, including current real estate value and projections of the finished value using the business plans, drawings, and designs you submitted previously.
6. Complete the Loan Closing
Once you obtain approval, the financial institution schedules a loan closing date. As part of the scheduled timeline, you’ll also get a draw schedule, which identifies when payments are distributed throughout construction phases.
It’s also typical practice to submit your down payment during this stage.
7. Enter the Construction Phase
Once your project commences, the bank will disburse payments according to the draw schedule.
8. Get Permanent Financing
Also known as construction-perm or construction-to-permanent loans, these one-time loans turn over as fixed-term loans upon completing your project. This type of loan can represent significant savings in paperwork, documentation, closing costs, and time.
Your financial institution will discuss your options for permanent lending before your project is completed.
