Financing Blog

An Introduction to Construction Loans

Finding a loan to fund a construction project is a tricky and often convoluted process, and it’s important to be prepared for all of its obstacles. There is a lot of paperwork and many procedural requirements that you should expect, and this brief guide aims to help you be more prepared to best navigate the search for construction loans.

First, you (the developer) must submit a loan request to a lender. Lenders are typically regional and community banks due to old legislation that restricted trade areas for lending, but enough time has passed that you may find support at some life insurance companies, national banks or other specialty finance institutions.

At this stage, you also have to consider whether you’re looking for short term or long term financing. Short term financing is generally paid off before the project is complete, but you typically don’t start paying off a long term loan until the project is complete and reaches occupancy. You’ll end up paying a higher rate over a longer period of time with long term financing, but sometimes the resources necessary for short term financing simply aren’t available.

After you’ve submitted your request, the senior lender at the institution you reached out to will approve or deny the project. If they approve, they will issue a non-binding term sheet with basic terms and conditions. Once you go through with that initial paperwork, institutions generally require your tax returns, financial statements, contingent liabilities, the loan uses, project plans, engineering specifications and a list of the real estate that you own for the loan underwriting process.

A credit check is involved and doesn’t differ much from other loan credit checks, but in construction loans a heightened emphasis is placed on the quality and expertise of the development team and the general contractor, since they are largely responsible for the project’s finished result

Another unique element of the construction loans process is that the real estate proforma (how much the property is expected to earn) is carefully considered.

Finally, the lending institution composes a binding term sheet. There are a lot of technicalities involved and a lot of legal terminology to sift through. Generally, the borrower and the lender bring attorneys to help navigate this final step.

Once this last sheet is complete and signed, you’re on your way to completing your project. Bear in mind that these loans are typically dispersed on a monthly basis, so you’ll need to think carefully about how and when to use the money.