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What Is A Construction Loan? Types Of Construction Loans

Written by Banks Editorial Team

Updated May 29, 2023​

3 min. read​

When you’re running a construction company or a small business looking to build your own space, you need the financing to build. From supplies to labor, construction projects can be expensive. You don’t want to rely on your cash reserves, making a great option a construction loan. But which one? Depending on your needs, there are many types of construction loans available to help you grow your business and realize your building goals.

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What Are Construction Loans?

Construction loans are funding options for a person, business, or construction company to access the money they need to complete a building project. This can include private homes, retail centers, industrial buildings, and land acquisition. There are many types of construction loans available to individuals, businesses, and contractors to start and complete a project. You need to know your options and understand your unique needs.

Types of Funding for Construction Projects

Whether you’re looking for traditional funding options or need to be a little more creative, various funding options are available for construction projects. Some options rely on a specific condition, such as acquiring the land, while others are broader. You might need a loan for construction that turns into a mortgage once the building or home is complete, or you may need funding for labor and supplies while you’re completing a project for a client. Here are some of your options.

1. Construction Mortgage Loans

Most people are familiar with mortgages, whether for a family home or a retail property you want to buy and run a business. But what happens when you want to purchase land and custom build a space? Construction mortgage loans fill this need. You can find a few types, and you need to choose the option that best suits your purpose and goals.

2. Construction-to-Permanent Loans

A construction-to-permanent loan is a type of product sometimes referred to as a single close loan. It covers the construction cost during the building process and then converts to a mortgage after it’s done. This can save you the expense of closing on two different loans. However, like a traditional mortgage, you need a certain level of good credit and possibly a down payment to secure it.

3. Commercial Construction Loans

A commercial construction loan covers the cost of building a commercial building. It could be a retail shop or industrial space. When you secure a commercial construction loan, you can use it to build a new building, or in some cases, to renovate an existing building.

These are considered a short-term loan and only covers the time of construction. When the project finishes, you need to sell it to repay the loan or take out a mortgage on the property. Here are a few common types of commercial construction loans.

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Commercial Construction Loans

Commercial construction loans are a class of loans designed to provide funding for supplies and labor for new retail or industrial buildings, develop the land, or acquire acreage to develop it. These loans are generally available for companies and not individuals, although if you’re new to contracting, the lender may look at your personal credit. In most cases, these are short-term loans meant to be repaid after the project finishes.

Land Development Loans

A land development loan provides funding for the very specific purpose of developing raw land. This can include things such as clearing trees, building roads, and designing access for utilities. When this loan’s conditions are complete, you don’t have a building or a home, but instead, land that you can more easily build upon.

Construction Loans

A construction loan is a traditional loan to construct a building of some sort. The building can be a home, retail business, industrial warehouse space, or some other construction product. It’s a short-term loan that you repay when the project is complete. It covers the costs of construction, including building supplies and labor. It might include the land or the creation of blueprints and construction plans.

Acquisition and Development Loans (A&D Loan)

With an acquisition and development loan, you use part of the funds to purchase the land. Once you purchase the land, you can use the remaining funds for both hard and soft costs. You can also keep part of the funds in reserve for any contingencies. This is also a short-term loan that you’re expected to repay when completing the funds’ uses.

Mini-Perm Financing

Mini-perm financing is a short-term loan that allows you to repay a construction loan and keep the property afloat until you can start making money from it. This type of funding is also short-term, and you can expect to pay it off within three to five years. You might use this type of financing to bridge the time between paying off the construction loan and getting approval for a mortgage.

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SBA Construction Loans

The Small Business Administration (SMB) sometimes guarantees construction loans. The SBA construction loan is backed by the government and paid out by a bank or other lender type. This type of loan provides more security for the lender. It’s a short-time loan, and it’s designed specifically for small businesses.

Takeout Loan

A takeout loan is a type of loan where you get a guarantee of certain funds at a specific time during the construction process. In some cases, the particular time is a date, while in others, it’s when certain milestones are met. This is a long-term funding option. A takeout loan is used to pay off a short-term loan, such as a construction or land development loan in many cases.

How to Choose the Loan for Your Commercial Construction

The first step in choosing a loan for commercial construction is understanding the options. You need to select a loan product that helps you protect your cash reserves while providing you with a low enough interest rate to make a difference. You also need to determine what you need the money for, such as construction versus land development. It’s always a good idea to shop around various lenders for the best interest rates.

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