Undertaking a new construction project is always an exciting endeavor and an important step in taking your business to the next level, but finding the right financing option and meeting all the requirements can often be a challenge.
As a leader in commercial construction loan financing, National Business Capital is well aware of the challenges and uncertainties that come with initiating new projects and getting funding for them.
For this reason, we have come up with a comprehensive guide to help you navigate the key requirements for commercial construction loans. So, let’s get right into it:
Construction loans allow builders and contractors to finance new building projects. But can limited liability companies (LLCs) get construction loans too? The short answer is yes. LLCs are eligible for construction financing just like other business structures.
In this comprehensive guide, we’ll explain everything LLC owners need to know about securing construction loans for their projects including
- What construction loans are and how they work
- Types of construction loans available
- Construction loan requirements for LLCs
- How to get a construction loan for your LLC
- Pros and cons of using an LLC for construction lending
What Are Construction Loans and How Do They Work?
Construction loans are short-term financing options intended to cover the costs of constructing new residential or commercial buildings The funds can be used to purchase land, pay for labor and materials, and cover other expenses related to building projects
Unlike regular mortgages construction loans provide funding in stages based on the progress of construction. This incremental funding helps reduce lender risk. Borrowers only pay interest on the loan during the construction phase. Once the project is finished the loan can be converted into a permanent mortgage with full monthly payments of principal and interest.
Construction loans typically have terms of 6-24 months. Interest rates are higher than conventional mortgages to compensate for the increased risk. Down payments of 10-25% are usually required.
Types of Construction Loans for LLCs
LLCs looking to finance construction have several loan types to choose from:
Construction-Only Loans
- Only cover building costs
- Must convert to permanent financing after construction
Construction-to-Permanent Loans
- Combine construction loan and mortgage
- Convert to mortgage after project completion
- Requires only one closing
Renovation Loans
- Finance upgrades and renovations for existing buildings
- Can be used by current owners or new purchasers
Land Loans
- Finance land purchase separately
- Combine with construction loan later
SBA 7(a) Loans
- Government-guaranteed financing up to $5 million
- Low down payments and lenient credit requirements
SBA 504 Loans
- Government real estate and equipment loans
- Offered through non-profit lenders
- Low down payments of 10%
Choosing the right loan depends on your project timeline, budget, and plans for the property after construction.
Construction Loan Requirements for LLCs
Like any business loan, getting construction financing as an LLC involves meeting certain eligibility standards. Typical requirements include:
Credit Score – A minimum personal credit score of 650-680 is usually required. As an LLC, your business credit will also be reviewed.
Down Payment – Expect to put down around 10-25% of the total project costs. Some lenders may offer low or no down payment options.
Debt-to-Income Ratio – Your maximum backend DTI can’t exceed 45% in most cases.
Collateral – The land and future building will be used as collateral. You may need to pledge additional business or personal assets.
Experience – Lenders prefer borrowers with a solid history of completed projects similar to the one being financed.
Plans and Specs – Detailed project plans, budgets, timelines, permits, and specifications must be submitted.
Meeting these requirements demonstrates you can successfully manage the risks of construction lending.
How Can an LLC Get a Construction Loan?
If your LLC meets the eligibility criteria, here are the main steps to getting a construction loan:
1. Submit a Loan Application
Provide details on your LLC, owners, project plans, costs, collateral, and financing needs. Personal and business tax returns are usually required.
2. Get Pre-Approved
If approved, you’ll receive a pre-approval letter detailing loan terms, rates, fees, and conditions. This letter can also be used when placing bids or negotiating with sellers.
3. Find a Suitable Property
Your lender can tell you the maximum loan amount you qualify for. Search for land or existing buildings that fit within your approved budget.
4. Complete Due Diligence
The lender will order property appraisals, title searches, and environmental reviews to confirm feasibility and mitigate risks.
5. Close on the Loan
At closing, you’ll provide any required down payment and pay loan origination fees. You’ll also sign loan documents and liens giving the lender a secured interest.
6. Prove Construction Progress for Draws
As work advances, submit invoices, receipts, and inspection results to receive scheduled draws from the loan pool. Draw requests are typically processed within 5-10 business days.
7. Convert to Permanent Financing
If you got a construction-only loan, work with your lender to refinance into a mortgage once the certificate of occupancy is issued.
Following these steps helps ensure smooth financing for your LLC’s construction project.
Pros of Using an LLC for Construction Loans
There are several advantages to securing construction financing under an LLC structure:
Limited Personal Liability
LLC owners are not personally responsible for business debts and liabilities. This can protect your personal assets if the project fails. Creditors can only make claims against the LLC.
Separate Business Identity
Lenders can assess the LLC’s finances separately from your personal finances. This allows them to base decisions purely on the LLC’s creditworthiness.
Pass-Through Tax Treatment
LLCs don’t pay taxes themselves. Profits and losses pass through to members’ personal returns. This avoids double taxation.
Flexible Management Structure
LLCs allow member-managed or manager-managed arrangements. You can choose the management structure that best fits your needs.
Credibility
Being an LLC evokes a professional, legitimate business image that some lenders prefer over sole proprietors.
Cons of Using an LLC for Construction Loans
However, there are also some potential downsides:
Higher Startup Costs
Forming an LLC costs more upfront than a sole proprietorship. There are state filing fees and ongoing compliance requirements.
Lower Approval Odds
Lenders may view new LLCs as riskier and prefer older, more established entities with long credit histories.
Personal Guarantees
Even with an LLC, most lenders will require personal guarantees from members securing the loan with their own assets.
Difficulty Raising Capital
LLCs can only raise capital through debt or equity from members. Sole proprietors may find it easier to attract investors.
Self-Employment Taxes
LLC members must pay self-employment taxes on their share of profits, which can increase tax costs.
Weighing these pros and cons will help you decide if using your LLC is the right choice.
Finding the Best Construction Loan for Your LLC
If you decide to move forward with getting construction financing under your LLC, follow these tips to find the best loan:
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Shop and compare rates from multiple lender types – banks, credit unions, online lenders, SBA lenders, etc. Rates can vary widely.
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Look for lenders that specialize in construction lending. They will understand your business needs best.
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Ask about origination fees. The lowest rates may have high upfront costs that erase savings over time.
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Prioritize flexibility. Seek lenders that allow you to customize payment schedules and draw amounts.
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Review loan terms carefully. Some lenders impose penalties for late draws or project delays.
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Choose lenders willing to finance a higher percentage of costs. This reduces cash you’ll need to raise.
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Ask lenders to explain their process for approving draw requests. Delays in funding can jeopardize projects.
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See if lenders offer dedicated construction loan advisors. Having guidance can be invaluable for LLCs new to the process.
With the right lender, an LLC can secure funding on favorable terms to turn construction plans into reality. Reach out to reputable lenders that understand the unique needs of LLC construction projects.
The Bottom Line
Construction loans are an essential source of financing for LLC contractors and builders embarking on new real estate projects.
Despite misconceptions, LLCs are definitely eligible for construction loans, but will need to meet high standards regarding collateral, credit, experience, and preparation.
Weighing the pros and cons of using your LLC as the borrowing entity can ensure you make the best business structure decision. Shopping around and comparing multiple loan offers is key to maximizing affordability and probability of approval.
With careful planning, diligent preparation, and meticulous execution, virtually any LLC has the ability to obtain the financing necessary to successfully undertake their dream construction project. The path to getting started begins with reaching out to experienced construction lenders willing to cater loans to the situation of your unique business.
Maintain a personal and business credit score
When it comes to the main requirements for commercial construction loans, one of the most important ones is to maintain a high personal and business credit score. A strong credit score signals to lenders that you have a history of managing credit responsibly.
It also indicates that you make your payments on time, are able to manage debt effectively, and pose a lower risk as a borrower when it comes to loan default. In addition, having a high score shows reliability and predictability in financial dealings, which is highly valued considering the uncertain realm of construction financing.
Your credit score will impact your:
- Loan eligibility – failing below the lenders’ threshold may result in loan rejection
- Loan terms – A higher credit score can give you more favorable loan terms
- Interest rates – It can also help you qualify for lower interest rates and higher limits
Business credit scores are measured on a different scale than personal ones, and they are typically based on the Dun & Bradstreet PAYDEX scale. For commercial construction loans, aim for a score of 75 or higher (out of 100).
If you are applying for a commercial construction loan, your personal credit score as a business owner also matters. Most lenders prefer a minimum personal credit score of around 680 to 700.
To maintain a good credit score, make sure to:
- Pay the bills of your business on time
- Ensure prompt payments to suppliers and creditors
- Monitor your credit reports from bureaus like Dun & Bradstreet and Experian
- Develop relationships with suppliers and vendors that offer credit terms
- Keep your credit utilization ratio low, ideally under 30%
- Keep your debt at manageable levels
- Limit new credit inquiries before applying for the loan
- Diversify your business credit portfolio
- Maintain healthy cash flow and strong financials
- Establish a good business credit history
Having a high credit score is among the most important requirements for commercial construction loans, so start working towards it as soon as possible before applying for a loan.
Prepare a comprehensive project plan
When it comes to commercial construction loans requirements, another important factor that we need to mention is the preparation of a comprehensive project plan. A good project plan should include:
- Scope of the project, clearly outlined when it comes to objectives, size and type
- Feasibility study to assess market demand, financial viability and potential risks
- Realistic timeline for the project, from key milestones to construction phases
- Risk management plan to identify potential risks and how you plan to mitigate them
- Budget and financial projections covering costs and revenue projections
- Appraisals and market analysis to support the feasibility of the project
- Loan repayment plan to show lenders how you plan to repay the loan
- Legal and regulatory compliance, including zoning laws and building codes
- An outlined exit strategy, such as selling, leasing, or refinancing the property
In addition, make sure to identify the project team, including the architects, engineers, and contractors that you are planning to work with, as well as their qualifications and past project experience.
Working with a highly seasoned and experienced team will increase the credibility and trustworthiness of your construction project, making it more likely to get an approval from the lender.
LLC Mortgage Loan Requirements To Purchase Real Estate
FAQ
How does an LLC get approved for a loan?
What is the minimum FICO score for a construction loan?
Can SBA loan be used for construction?
Can an LLC make a loan to a member?
Do small businesses need a commercial construction loan?
When it comes to funding your project, your small business might need a commercial loan to give you the resources to start. Read on to learn more about commercial construction loans, when you should consider applying for one, what you can expect from the application process, and how they differ from commercial real estate loans.
What is a construction loan?
A construction loan is short-term financing that can be used to cover the costs associated with building a house, from start to finish. Construction loans may cover the costs of buying land, drafting plans, taking out permits and paying for labor and materials.
How do you make money with a commercial construction loan?
Here is a list of our partners and here’s how we make money. A commercial construction loan is a kind of business loan that helps your company cover the costs associated with building or renovating structures. You can use these construction business loans to purchase land, buy materials and pay workers.
Is a construction loan right for You?
If a construction loan is not right for you, consider these alternative small business loan options: Equipment financing: This type of financing allows you to spread the cost of an equipment purchase over several years. Equipment financing loans are particularly well suited to construction businesses that need costly equipment to operate.