What is a Commercial Construction Loan?

Last updated on February 2nd, 2024 at 06:49 pm

May 16, 2022
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You’ve met with your skilled commercial construction experts and have planned out your project. Now you’re going to need financing to move forward. That’s where commercial construction loans come in. These loans offer different funding options allowing you to get the needed money to complete your dream commercial construction project. While this process can be confusing and feel stressful, you’ve come to the right place to form a great starting point in moving forward.

How do Commercial Construction Loans Work?

One of the perks of a commercial construction loan is that you don’t receive the money in a lump sum upfront. You’ll work with your lender to set up a draw schedule. This means a partial amount of the loan is released as projects hit specified milestones. An inspector will confirm the agreed-upon milestone has been hit, and then the lender releases the next draw. Here’s why this is great: You only pay interest on the portion of the loan that has been received! Let’s say you took out a loan for $600,000 and your first draw is $100,000. This means you only pay interest on that first $100,000 until the next draw. Then, you add that sum together and pay interest on the total.

You can often talk with your lender about structuring your loan to only pay interest until the loan is fully disbursed. Then, you can pay off the principle in a lump sum at the end of your commercial construction project. If you’re unable to make one large payment, you can switch to a commercial mortgage. Your property then serves as collateral and you can use the mortgage to back the commercial construction loan. This works well because a commercial mortgage locks you in at a more affordable monthly payment over a longer period of time.

If you decide to take out a Small Business Administration CDC/504 loan, you generally won’t need to take out additional loans following the completion of your project. This loan offers lower down payments and more long-term options. The downside to this type of commercial construction loan is that it’s incredibly selective about borrowers and the usage of funds. Also, your operating expenses can’t exceed 25% of the total value of eligible fixed assets.

Commercial Construction Loan Interest Rates

Just like with any loan, the better your credit score, the lower your interest rate. You should expect to pay between 4% and 12% on your commercial construction loan. This could also depend on your lender as well. A bank will typically have the lowest interest rate, while hard money lenders charge a higher rate since they are usually willing to take more risks.

Down Payment on Your Loan

A commercial construction loan is considered a “high-risk” loan. Because of that fact, lenders will require a down payment. This helps mitigate risks on their end. You can expect to pay between 10%-30% of the total project cost. 

Most lenders will not cover 100% of the project. They will use a loan-to-cost calculation. That means your lender will divide the total amount of the loan requested by the total project cost. Every lender is different, but most require the loan-to-cost to be between 80% to 85%.

Types of Commercial Construction Loans

SBA CDC/504 Loan Program – This is one of the most popular construction loans. It has low down payments, competitive interest rates, and requires a credit score in the high 600s.

  • No maximum borrowing amount, but the SBA will only fund up to $5 million.
  • 10 or 20-year term lengths
  • Borrowing fees are rolled into the interest rate or cost of the loan
  • Guarantee required from anybody who owns at least 20% of the business
  • Collateral is required
  • Down payment is between 10%-30%

SBA 7(a) Loan Program – This can be used for the purchase or construction of commercial real estate. To qualify, you’ll need a credit score in the high 600’s and a down payment of 10%-20%. Interest rates are based on the prime rate plus a maximum of 2.75%.

Bank Loans  – A commercial construction loan from a bank is a more traditional option. Rates, repayment terms, and down payments will vary greatly depending on the institution. You can expect a minimum down payment of 10%, a maximum repayment term of 25 years, and the options of fixed or variable rates. 

Mezzanine Loans – These are great when you’re struggling with the loan-to-cost ratios. If your ratio is lower and you need to come up with additional money, this is the loan to help. Mezzanine loans are secured with stock. If you default, the lender can convert to an equity stake. With this loan, you have more leverage during the loan-to-cost ratio conversations.

The Diamond Standard

No matter which commercial construction loan you go with, you need to feel secure in the company you choose to complete your projects. With Diamond Contractors, you’ll be working with one of the best commercial construction companies in Kansas City. We’re licensed and insured in 44 states. We work hard to build a solid rapport with our clients and subcontractors across the country. We have the experience and aptitude to give you competitive bids in your market. Our Diamond Standard isn’t just about the polished end result. It’s about delivering the highest quality experience to our customers every step of the way. We’ll put you first and help guide you in the right direction.


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