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How Construction Business Loans Work

Written by Allison Martin

Allison Martin is a personal finance enthusiast and a passionate entrepreneur. With over a decade of experience, Allison has made a name for herself as a syndicated financial writer. Her articles are published in leading publications, like, Bankrate, The Wall Street Journal, MSN Money, and Investopedia. When she’s not busy creating content, Allison travels nationwide, sharing her knowledge and expertise in financial literacy and entrepreneurship through interactive workshops and programs. She also works as a Certified Financial Education Instructor (CFEI) dedicated to helping people from all walks of life achieve financial freedom and success.

Updated November 6, 2023​

8 min. read​

construction business loans

Constructing a property requires significant resources, but not every construction company has enough cash available for each project. Construction business loans cover the difference. Companies use these loans to gain market share in the construction industry through leverage. Many businesses use loans to reach new customers and use lending partners to get adequate financing. We’ll share how these loans can impact your business and the best ways to use a construction business loan.

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How Do Construction Business Loans Work?

Construction companies take out short-term business loans to build or renovate a property. Most of these are 6–24-month term loans, but some extend 15-30 years. Longer loan terms cost less per month, letting you keep more of your cash flow. However, a longer loan also leads to more interest payments. You save more at the moment but pay more over the loan’s lifetime.

Lenders will also require larger down payments since the property isn’t finished. An unfinished property is less attractive collateral for the lender. You may have to find enough funds to make a 20% down payment on the loan. After making the down payment, the lender will give you a portion of the loan’s principal. Lenders hand out the loan amount based on a schedule instead of giving you the money immediately. This distinction sets commercial construction loans apart from small business loans. The lender gives you more of the loan’s amount based on milestones such as establishing the property’s foundation. You only receive additional funding if you move forward with the project.

Construction companies only pay interest on the money they borrow. Restricted funds tied to milestones don’t accumulate interest until the lender lets you access those funds.

In addition to the factors mentioned above, there are several other important considerations when it comes to construction business loans. For example, lenders will typically require detailed plans and blueprints for the property being built or renovated. This is because they need to assess the feasibility of the project and ensure that it will be completed on time and within budget.

Another important consideration is the interest rate on the loan. As mentioned earlier, longer loan terms can result in lower monthly payments but higher overall interest payments. It is important to carefully consider the interest rate and repayment terms when choosing a construction business loan.

In addition, construction business loans may come with fees and other charges. For example, lenders may charge an origination fee, which is a percentage of the loan amount. There may also be fees for appraisals, inspections, and other services related to the construction project.

It is also important to consider the impact that a construction business loan will have on your cash flow. While the loan can provide the necessary funds to complete the project, it will also require regular payments over the loan term. This can impact your ability to manage other expenses and investments in your business.

Loans for construction companies have several capabilities. We’ve outlined some of the common ways business owners use construction financing.

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Land Acquisition

Acquiring land gives you a place to build a commercial or residential property. You can use a construction loan to finance the purchase. Some business owners buy land and don’t construct it right away. Land is limited, and once land gets snatched up, another piece of land may not become available in the same area. You can acquire land to claim your stake and wait before constructing the property. Then, if you have enough funds or can get the necessary financing, you can start construction immediately.

Labor and Permits

You can’t buy land and immediately start building a property. Construction businesses must first obtain permits and written documents from a city or county that approves their construction activity. Obtaining permits and hiring workers to construct the property cost money. Construction companies can see a great return on their investment once the property gets built, but they have nothing until then. Construction companies can get financing to move the project along.

Building Materials

Workers need the necessary materials to build your property. These materials add to your overall expenses. If you don’t have enough money for building materials, workers, and other costs, lenders can give you the necessary funds to buy these resources.

Repairs and Renovations

Not every project requires building a structure from the ground up. Some clients want repairs and renovations. Under this circumstance, you can still get a construction loan. You’ll need the money for workers, materials, and other expenses.

Professional Fees

Every construction company gets a blueprint before building a property. Obtaining architectural designs from professionals is a necessary expense, and a construction loan can cover it. In addition, you can get financing for additional professional services such as appraisals and inspections.

Construction Fees and Costs

You can use a construction loan for any fees and costs that occur during construction. Fees and costs vary, but you’ll have to pay several fees for loan origination. All of these fees can get tacked onto the loan’s principal.

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Cash Flow Maintenance

Want some extra cash to pay salaries on time? Loans provide a war chest of funds you can tap into at any time. You can get a construction loan for this purpose, but a regular business loan without milestone-based distributions may make more sense.

Options For Construction Business Loans

Construction business owners can use several financial products to receive funds. We have outlined some of the most popular choices below.

Equipment Financing

Equipment financing is a type of loan that provides construction companies with the necessary funds to purchase new equipment, repair old equipment, or replace unusable equipment. Construction companies rely heavily on equipment to complete their projects, and having access to the latest and most advanced equipment can give them a competitive edge in the industry.

However, the equipment can be expensive, and not all construction companies have the funds to purchase it outright. This is where equipment financing comes in. The loan amount will depend on the cost of the equipment, the creditworthiness of the borrower, and the terms of the loan.

One of the benefits of equipment financing is that it can help construction companies to stay on top of their cash flow. Instead of having to pay for equipment upfront, construction companies can spread the cost of the equipment over a period of time. This can help them to preserve their cash flow and use their funds for other business expenses.

Equipment financing can also provide construction companies with tax benefits. The interest paid on equipment financing loans is tax-deductible, which can help to reduce the company’s tax liability. In addition, equipment financing can help construction companies to improve their credit score. Making timely payments on equipment financing loans can help to establish a positive credit history, which can make it easier for the company to obtain financing in the future.

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Invoice Factoring

Invoice factoring is a financing option that can be particularly useful for construction companies that have a lot of outstanding invoices. When clients are slow to pay or make late payments, it can create cash flow problems for construction companies. Invoice factoring can help to address these issues by providing immediate access to capital.

Invoice factoring works by selling your outstanding invoices to a factoring company. The factoring company will pay you a percentage of the invoice’s face value, typically between 70% and 90%. The factoring company will then collect the full amount of the invoice from your client when it becomes due. Once the factoring company has collected the full amount, they will pay you the remaining balance minus their fees.

One of the benefits of invoice factoring is that it can provide immediate access to capital. Instead of waiting for clients to pay their invoices, construction companies can sell their invoices to a factoring company and receive a payment within a few days. This can help to improve cash flow and ensure that the company has the funds it needs to continue operating.

Another benefit of invoice factoring is that it can help to avoid debt. Unlike loans, invoice factoring does not require you to make monthly payments. Once you sell an invoice to a factoring company, you are no longer responsible for collecting payment from your client. This can help to reduce the administrative burden of managing outstanding invoices and free up time to focus on other aspects of the business.

Invoice factoring can also be a good option for construction companies that have difficulty qualifying for traditional loans. Factoring companies typically look at the credit worthiness of your clients, rather than your own credit score, when deciding whether to purchase your invoices. This means that even if you have poor credit, you may still be able to qualify for invoice factoring.

However, it is important to note that invoice factoring can be more expensive than other financing options. Factoring companies typically charge a fee for their services, which can range from 1% to 5% of the invoice’s face value. This fee can add up over time, particularly if you have a lot of outstanding invoices.

In addition, invoice factoring can impact your relationship with your clients. When you sell an invoice to a factoring company, the factoring company takes over the responsibility of collecting payment from your client. This can create confusion or frustration for clients who may not understand why they are receiving payment requests from a third party. It is important to communicate clearly with your clients.

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Business Line of Credit

A business line of credit is a type of financing that can be used for any expense in your company. Unlike a traditional loan, a business line of credit provides a revolving line of credit that can be borrowed at any time. Once the line of credit is fully paid off, it remains accessible, so you don’t have to apply for another line of credit to access your funds.

One of the benefits of a business line of credit is that you only pay interest on the amount you borrow. This means that if you don’t need to use the line of credit, you won’t be penalized for holding onto it. This can be a great option for businesses that want to have access to funds in case of an emergency or unexpected expense.

A business line of credit can also act as short-term financing to cover urgent expenses. For example, if a construction company needs to purchase materials for a project but doesn’t have the funds available, it can use a business line of credit to cover the expense. Once the project is completed and the company receives payment from the client, it can pay off the line of credit.

It is important to note that a business line of credit typically comes with a higher interest rate than other types of financing unless it is secured with collateral. This is because the lender is taking on more risk by providing a revolving line of credit that can be accessed at any time. However, if you have good credit and a strong financial history, you may be able to negotiate a lower interest rate.

Another benefit of a business line of credit is that it can help to improve your credit score. Making timely payments on your line of credit can help to establish a positive credit history, which can make it easier to obtain financing in the future. In addition, a business line of credit can help to build a relationship with a lender, which can be beneficial if you need to obtain financing for larger projects in the future.

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SBA 7(a) Loan

SBA 7(a) loans are a popular financing option for small businesses. These loans are backed by the Small Business Administration (SBA), which means that they are guaranteed by the government. While SBA loans come with stringent requirements, they are often easier to obtain than loans from traditional banks.

To qualify for an SBA 7(a) loan, you will need to demonstrate strong revenue and earnings, along with a high credit score. The SBA typically requires a credit score of at least 680 for borrowers. In addition, you will need to provide detailed financial statements and projections, as well as a business plan that outlines your goals and strategies.

One of the benefits of an SBA 7(a) loan is that it can be used for a wide range of business expenses. This includes everything from purchasing equipment and inventory to hiring employees and expanding your business. The maximum loan amount for an SBA 7(a) loan is $5 million, which can be a significant amount of funding for small businesses.

Another benefit of an SBA 7(a) loan is that it typically comes with lower interest rates than other types of financing. This can help to reduce the overall cost of borrowing and make it easier for businesses to repay the loan over time. In addition, SBA loans often come with longer repayment terms than traditional loans, which can provide more flexibility for businesses.

It is important to note that the SBA does not give loans directly. Instead, it backs loans from its partners, which include banks, credit unions, and other financial institutions. This means that you will need to work with a lender that is approved by the SBA to obtain an SBA 7(a) loan.

While SBA loans can be a great option for small businesses, they do come with some drawbacks. For example, the application process can be lengthy and time-consuming, and the SBA may require additional documentation or information throughout the process. In addition, SBA loans can be more difficult to obtain than other types of financing due to the strict eligibility requirements.

Another potential drawback of SBA loans is that they often require collateral. This means that you will need to put up assets, such as real estate or equipment, as security for the loan. If you are unable to repay the loan, the lender may seize these assets to recoup their losses.

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