2 Things You Must Do With Your Commercial Construction Loan

Applying for a commercial construction loan is a long, arduous process, so you may be tempted to start spending the money right away once you're approved. However, it's important you take care of two important financial issues before you begin investing the money in your project to avoid serious problems that may develop down the road.

1. Set Aside Cash for Interest Payments

When banks approve commercial construction loans, they're taking a huge risk. Since there is no physical property to secure the loan yet, they have to essentially take you at your word that you will finish the project and start repaying the loan as agreed. Because of this increased risk, it's pretty common for banks to demand construction companies begin making interest-only payments on the loan. So, by the end of the first month or two, you can expect to receive a notice from the bank asking for money.

This may seem unfair since your project is still under development and not making any money but, unfortunately, there's no way around this issue. If you don't have cash coming in from other investments, then one thing you'll have to do with your construction loan is set aside a portion of the money to make the interest payments as required.

It can be challenging calculating exactly how much money you should set aside. Start by estimating how long your project will take and calculate the number of months by the amount of the expected interest payment. So, if you're being charged 5% interest on a $100,000 loan and your project will complete in six months, you should set aside $30,000 (i.e. $5,000 x six months) or as much as you can afford. This way, you'll be able to make the interest payments and avoid defaulting on the loan.

2. Set Aside the Annual Fee

Another cost you need to budget for is your loan's annual fee if one is being charged. It's not unusual for banks to charge an origination fee that must be paid upfront plus an annual loan fee that must be paid on a yearly basis.

For instance, the bank may charge a 1% origination fee and then a 1/4% annual fee that must be paid on your loan anniversary date. The origination fee is typically paid with closing cost, but the annual fee must come from your future profits. If you don't expect your project to wrap and start generating money within a year, then it's a good idea to set aside cash to pay the annual fee the bank is charging. For more tips on how to handle your loan disbursement or to apply for a commercial construction loan, contact a lender you trust.