How Large Commercial Construction Loans Work
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Published: Monday, May 19, 2008
As its name would imply, a construction loan is a loan that a borrower takes out to finance the construction of a residential or commercial type property. Commercial construction loans are meant to be short-term loans that get paid off when commercial construction is completed (typically when the certificate of occupancy is issued).
Because commercial construction finance loans are not standardized like mortgage loans that get sold to Fannie Mae and Freddie Mac, there can be variability in the features of various construction loan programs. Most construction loans do, however have many things in common, including:
- Construction loans typically have interest only payments during construction
- The interest rate on construction loans is usually priced at some amount above a short term interest rate
- The term on construction loans is typically six months to a eighteen months
- Construction loans come due upon completion of the project when the certificate of occupancy is issued
Borrowers using a construction loan will typically need another traditional mortgage to pay off the construction loan when it comes due. This process entails two mortgage applications with their associated fees, and two closings. To provide more convenience and to make the process easier, many lenders offer construction-to-permanent loan programs. A commercial construction-to-permanent loan program provides both the construction financing during the building phase, and then converts to a traditional mortgage loan when the certificate of occupancy is issued.
The advantage of a construction-to-permanent loan program is that the borrower has only one application and one closing with their associated costs. Construction-to-permanent financing programs can convert to fixed rate mortgages (FRMs), depending on the program being offered by a specific lender. All of the decisions about loan term and type of loan are made when the borrower closes on the loan prior to construction.
Many construction-to-permanent loan programs will be priced out with locks that limit the interest rate on the permanent loan. Because of the complexity of the two options available for financing construction it can be difficult for a borrower to compare a two loan option versus a construction-to-permanent loan.
One final alternative that may be available to the borrower is builder financed construction. In this case, the builder finances the construction and the borrower simply shops for and obtains a traditional mortgage when construction is completed. This may, depending on how the builder passes on costs, result in a higher price for the property than if the borrower had financed the construction themselves.
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Greatland Financial is your experienced Riverside commercial real estate lender offering Riverside’s commercial real estate investors extensive commercial loan programs.
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