What are some common sources of construction financing? There are eight common sources of construction financing:
- Commercial banks
- Savings and loan associations
- Mutual savings banks
- Mortgage banking companies
- Life insurance companies
- Real estate investment trusts
- Government agencies
- Alternate sources
#1 – Commercial BanksWhen looking into financing a major construction project, the first place you will likely start is with a traditional construction loan through a major commercial bank. A good thing about going with a major bank is that large construction projects are not cheap, with a significant loan required that may take many years to pay back. You can feel confident when choosing to finance your project through a commercial bank that they will have enough resources to cover your project and the financial strength to allow flexible repayment terms. Most commercial bank loans will require a down payment of at least 10 percent. This helps take some of the risks off the lender by showing them that your business has enough financial equity to handle a project of broad scope. In addition, most commercial banks offer fixed or variable interest rates and term lengths that can last up to 25 years. The following looks into some of the advantages of choosing a construction loan through several major commercial banks.
Wells FargoWells Fargo offers a variety of lending instruments for businesses looking to undertake a construction project, including secured loans, unsecured loans, and lines of credit. One particularly attractive option offered by Wells Fargo is a product known as FastFlex, which extends a one-year credit line of $35,000 to your business at an interest rate of around 14 percent. Whether or not you ever need to use the FastFlex option, it is great to have in place before starting a construction project, as it will allow you to quickly get unexpected materials that may pop up in the heat of the moment during a build. Wells Fargo’s application process is very intuitive, with a plethora of information available online. In fact, if you are a Wells Fargo member, you may be able to apply and get approved for your construction loan without ever going into a branch office.
Chaseis another commercial bank that may be an excellent option for financing your construction project. They offer several options that can help you get your project off the ground, including lines of credit, business term loans, and SBA loans. Chase may be the best option for larger companies breaking ground on grand-scale projects, as some of their SBA loans can provide up to $5 million in funding over a term of up to 20 years at some of the most competitive rates in the industry. The downside is that it can be challenging to qualify for some of Chase’s more attractive loans, so if you do not have an excellent credit rating or significant equity or collateral, getting approved for major financing through Chase may be an uphill battle.
U.S. BankIf you are looking to build west of the Mississippi, may be the best option for commercial financing, especially if your project is small or mid-sized, and you are looking for some quick lines of credit. U.S. Bank does offer business term loans and SBA loans, but its lines of credit truly set this institution apart, as they provide favorable rates through the following products:
- Cash Flow Manager Line of Credit – a $250,000 pool of money to fund your construction needs that do not require collateral to secure
- Business Equity Line of Credit – allows businesses with real estate equity to draw additional credit for up to 75 percent of the real property’s value
- Business Line of Credit – another form of a secured line of credit that allows you to secure the credit line against assets other than real estate
Bank of AmericaAs the second-largest bank in the United States, has the financial backing to fund hefty loan amounts. To meet the needs of your construction project, Bank of America offers Business Terms Loans, SBA Loans, and lines of credit. Like Chase, Bank of America is a great institution to term to if you need a multi-million dollar loan at a competitive rate. It also has a broad array of repayment options that can make amortizing these large loan amounts more palatable. The downside to Bank of America is that it tends to be a little challenging to get approved for a loan, especially if you are not already a business account holder with the institution. Also, the loan approval process is slower and more in-depth than some other industry leaders, with loans not available in some western states. One final drawback is that it can take a while for funds to disburse, a significant disadvantage when unexpected costs arise at the job site, especially when compared to the instant availability of funds with a product like Wells Fargo’s FastFlex.
#2 – Savings and Loan AssociationsSavings and loan associations (S&L) are less like commercial banks and more like credit unions, in which interests in the S&L are “mutually held, meaning that depositors and borrowers are members that have voting rights, making them eligible to control the institution’s goals” (Financial Wall Street). Due to the smaller, neighborhood-like feel of an S&L, the law prohibits S&L’s from committing more than 20 percent of their lending interests to commercial projects. This means that the majority of their loans are consumer-based mortgage loans. As a result of unsound lending practices that ended in the financial crisis of 2007, the number of S&Ls has dwindled over the years. Still, if you are a smaller business and are a member of an S&L or can gain access to financing through an S&L, its loans can offer some advantages for your construction project. The following are some benefits of taking out a loan through an S&L:
- One-time closing that results in fewer unexpected fees than is typical when borrowing from a larger commercial bank
- A locked-in interest rate that is guaranteed for the duration of the loan
- Interest-only payments, meaning that the monthly cost of an S&L construction loan will be comparatively small when placed next to other lending sources
#3 – Mutual Savings BanksA mutual savings bank is similar to an S&L in that it is member-controlled. Members of a mutual savings bank invest their money into a common fund, and this fund is invested into mortgages, stocks, bonds, and securities, with members sharing in the profits and losses of these investments. While there is some risk involved in being a member of a mutual savings bank, the advantages have been overwhelmingly favorable over the years, resulting in lower interest rates on loans and higher interest rates on deposited money for members. This is because mutual savings banks only invest member funds into low-risk, high-upside endeavors. Therefore, if your business is financially sound and the mutual savings bank is confident that your construction project will yield an excellent return on their investment, there is a chance that you can secure financing through this route. While it may not have the resources to fund multi-million dollar projects, mutual savings banks can offer the following to appropriately-scoped endeavors:
- Land loans for the purchase and development of residential buildings and commercial spaces
- Building loans for the construction of homes and apartment rentals
- Small business working capital loans
- Loans for the lease and purchase of construction equipment
#4 – Mortgage Banking CompaniesMortgage banking differs from traditional commercial banks in that they specialize in the origin and servicing of mortgage loans. Although they are dedicated to the area of mortgages, some large mortgage banks can actually handle a higher volume of loan dollars than commercial banks. The most popular mortgage banks differ from state to state and do not typically come with a major national name like Wells Fargo or Chase. Some popular brands that are more nationally recognized are SoFi Mortgage and Quicken Loans, but you will want to check your local institutions to see the mortgage instruments they offer in your area. In general, construction financing can be obtained through a mortgage banking company through the following method:
- An investor or landlord obtains a mortgage loan in a similar fashion that they would a mortgage for a traditional home purchase, making the distinction that construction will take place and specifying the contractors and scope of the project.
- The mortgage lending bank disburses the loan to the contractor — not the investor — as certain milestones of the construction project are completed.
- Once construction is complete, the investor takes over the cost of the mortgage and pays it off, similar to a traditional home mortgage.
#5 – Life Insurance CompaniesIf you are looking to undergo a large-scale construction project, you will definitely want to look into life insurance company loans, as these are arguably the best instrument for major commercial loans. Life insurance companies specialize in offering construction loans in four main areas: apartment, office, retail, and commercial properties. However, they can also finance other significant projects, such as hotels and restaurants, depending on the company’s assets. The minimum construction loan amount from most life insurance companies is $5 million (yes, you read that right—$5 million) with a maximum loan amount of 75% of the business’s total assets. When considering that the owners of many commercial spaces have hundreds of millions in assets, these loans can become quite hefty, depending on the project scope. Life insurance construction loans have the benefit of offering very favorable rates, as the loans are backed by an investor’s assets. In most cases, they are also free of closing costs, taxes, and additional fees. The downside to life insurance company loans is that they offer prepayment penalties. As most term lengths are 30 years, this means that you will be paying interest for a long time, which will ultimately offset the lower rates you receive upfront. In addition, if the investor were to default or become deceased before the loan is paid off, the balance would be taken out of the death benefit that was to be bequeathed to his or her beneficiaries.
#6 – Real Estate Investment TrustsReal estate investment trusts (REITs) are companies that own, operate, and finance income-producing projects. Simply put, if you are breaking ground on a project that has the potential to generate significant revenue, there is likely to be a REIT to fund your project. In general, REITs specialize in investment in a specific area, such as hotels, cell towers, or self-storage facilities. In fact, one of the hottest REITs on the market today is Innovative Industrial Properties, which specializes in the development of commercial marijuana facilities. Due to the nature of REITs, you are likely to be able to secure financing at very favorable terms for construction projects of a variety of sizes. However, there are a few crucial points to consider:
- You must find a REIT that specializes in an area that you are looking to build in.
- A REIT will only lend money to you if it is confident in your ability to turn a profit. Therefore, a rock-solid business plan and company structure must be in place before soliciting this type of financing.
- Depending on the terms of your loan, you may be required to pay some of your profits back into the REIT once construction is complete and your business is up and running.