The Complete Guide To Commercial Construction Loans

Unlike traditional loans, commercial construction loans are not paid out as a lump sum. Instead, funds are released in stages throughout the project.

• Draw Schedule: The lender and borrower create a draw schedule that outlines when funds will be disbursed. As project milestones are completed, portions of the loan are released. For example, one draw may cover site preparation, another the foundation, and another framing.
• Inspections: Before each draw is released, lenders typically require an inspection to verify that the work has been completed as planned.
• Interest: You only pay interest on the funds that have been disbursed. For example, if your total loan is $500,000 but you’ve only received $100,000 so far, you’ll only pay interest on that $100,000.

Some loan programs (like the SBA CDC/504 loan) provide more long-term options that reduce or eliminate the need for refinancing after construction is complete.

Commercial construction loan rates typically range from about 5% to 18%, depending on the lender, borrower qualifications, and project risk.

Traditional banks tend to offer lower rates, while private or hard money lenders usually charge higher rates.

Like most loans, commercial construction loans may include various fees. Common examples include:

• Guarantee fees
• Processing fees
• Documentation fees
• Project review fees
• Fund control fees

Be sure to factor these into the total cost of the loan.

Because commercial construction loans are considered high-risk, most lenders are going to require a down payment.

A down payment takes some of the risk away from the lender and is typically between 10% and 30% of the total project cost.

It’s rare for a lender to cover 100% of the cost of a construction project.

Instead, they use a loan-to-cost (LTC) ratio. LTC is calculated by dividing the loan amount by the total project cost.

For example:

A business requests a loan of $190,000 for a project that costs a total of $200,000

$190,000 / $200,000 = 0.95 (expressed as a percentage, the loan-to-cost ratio for this project would be 95%)

Requirements vary by lender, but most will require a loan-to-cost ratio of 80% to 85%.

Following the example above, the lender would loan between $160,000 and $170,000.

If your loan doesn’t cover the full cost, you’ll need to make up the difference — either with your own funds or through additional financing options, such as mezzanine loans.

The Small Business Administration (SBA) CDC/504 loan is one of the most popular commercial construction loans.

Borrowers are often drawn to this program for its relatively low down payments, competitive rates, and flexible qualification requirements.

With a 504 loan, financing is typically split three ways:

• A Certified Development Company (CDC) funds up to 40%
• A traditional lender (like a bank) funds around 50%
• The borrower contributes at least 10% (sometimes 15% to 20% for newer or higher-risk businesses)

Loan amounts for the CDC portion go up to $5.5 million, with repayment terms of 10, 20, or 25 years. Interest rates are tied to U.S. Treasury yields.

The SBA 7(a) program can also be used for construction, renovation, or purchasing commercial real estate.

Borrowers can access up to $5 million, with repayment terms of up to 25 years for real estate.

Interest rates are typically based on the prime rate plus a lender markup, with SBA-imposed caps (often up to 2.75% for larger loans).

Most borrowers will need solid credit (often in the high 600s or higher) and a down payment of around 10% to 20%, depending on the deal.

Traditional bank loans are another common way to fund commercial construction.

Terms vary widely, but borrowers can generally expect:

• Down payments starting around 10% to 30%
• Repayment terms up to 20 to 25 years (often after construction converts to permanent financing)
• Fixed or variable interest rates

If you’re considering this route, your existing bank is often a good place to start. Or check out our list of the best banks for small business loans if you’re interested in specific recommendations.

Mezzanine financing is typically used to fill funding gaps when a primary loan doesn’t cover the full project cost.

These loans are usually subordinate to senior debt and are often secured by equity rather than physical assets. If the borrower defaults, the lender may have the option to convert their position into an ownership stake.

Mezzanine financing can help increase total project funding, sometimes pushing the effective loan-to-cost ratio closer to 90% or more, depending on the structure.