Everything You Need to Know About Construction Loans

If you’re not in the business of developing real estate, you probably don’t know a lot about commercial construction loans, and mostly that’s okay. The industry is complex, and it’s built around the mutual needs of developers, builders, and lending institutions, so it’s not something the casual entrepreneur needs to research. If your company has reached the point where you need to expand your facilities, though, you might just find a construction loan is your most cost-effective option. At that point, it’s vital you understand how it’s different from other commercial loans, why that’s a good thing, and what to look out for as a first-time user.

How Construction Financing Works

When you take out a standard business loan, you’re typically financing on a model similar to a mortgage or secured vehicle loan. That makes the product easy to understand, but it also limits what it can do. If you own your current building, taking out a loan against it to finance improvements is an expensive option that might engage you financially for a decade or more. Unsecured financing is typically unavailable, and options that are designed for short-term investors just won’t work. Construction loans are structured in tiers, with more financing available as you reach certain construction milestones, allowing you to control the process more closely and limiting your financial exposure if something goes off-track as you build.

Why Milestone-Based Financing Is a Good Option

Construction loans use the equity currently in a property to determine the available finances. Achieving milestones means more value has been built into the property, and it unlocks more funding to continue the construction. As a result of this limitation of risk, lenders can afford to offer better rates than they would be able to offer through other instruments bent to this purpose. On top of that, there is often a support system for investors using these loans, and those resources can make a huge difference for companies building a facility for the first time.

What To Look Out For

The biggest pitfall clients face when they get construction loans is a failure to finish the project on time and under budget. Accurate cost projections are the key to making this work, as well as the presence of a cash reserve in case of emergencies. Make sure you budget to hold a reserve against overruns when you consider how much you will be able to put down on a construction loan to get started. It’s also important to have contractors who can perform excellent work efficiently, and that requires a whole extra set of tools that require their own article to unpack.

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