Loan type
Commercial construction loans: how the money actually arrives
You do not receive the money at closing. You draw it in stages against inspected work, and the gap between those two facts is where projects get into trouble.
At a glance
| How funds arrive | In draws, against completed and inspected work |
|---|---|
| Payments during build | Usually interest-only, on the drawn balance only |
| Term during build | Typically the construction period plus a buffer |
| What happens after | Converts to permanent financing, or you refinance it |
| Rate | Commonly variable, priced over prime |
| Retainage | A percentage of each draw held back until completion |
| Equity expected | Substantial, and usually in before the lender funds anything |
A good fit when
You are building, expanding or substantially renovating, you have a contractor and a realistic budget, and you can carry the project between draws.
A poor fit when
You need the full amount up front, your budget has no contingency, or you are relying on the construction loan to fund your own working capital.
The thing that surprises first-time builders
A construction loan is not a lump sum. The lender approves a total, then releases it in draws as work is completed and inspected. You are financing the project a stage at a time, and in most structures you pay for the work before the draw reimburses you.
That timing is the single most common cause of distress on otherwise sound projects. The contractor wants paying, the inspection has not happened, and the draw is two weeks out.
How the structure works
Your equity goes in first
Lenders generally want to see your contribution spent before they release anything. Budget for carrying the earliest stage entirely yourself.
Draws against completed work
An inspector or the lender verifies the stage is finished, then the draw funds. Expect a fee per draw and expect the inspection to take time.
Interest-only during construction
You pay interest on what has been drawn, not on the full approval, so early payments are small and grow as the project does.
Retainage held back
A share of each draw is retained until the work is complete and signed off. Your contractor is in the same position with you, and it is a standard source of friction.
Conversion or refinance
At completion the loan either converts to permanent financing or must be refinanced. This is the step to settle before you start, not after.
Where the SBA fits
Both main SBA programmes can fund construction, and for owner-occupied property the economics are usually better than conventional.
- SBA 504 is frequently the strongest option for building or expanding owner-occupied premises: a long fixed rate, fully amortizing, no balloon, which removes the conversion risk entirely.
- SBA 7(a) can cover construction as part of a mixed project — building plus equipment plus working capital in one loan.
- Builders CAPLine is the specific programme for small general contractors building or rehabilitating property for resale, and it is the explicit exception to the SBA's general rule against financing property held for sale.
- USDA B&I for larger rural projects.
Renovation, fit-out and build-out
Not every project is a new building. Refitting a leased unit — a restaurant kitchen, a salon, a clinic, retail shelving — is financed differently from ground-up construction, and the lease is what complicates it.
- Leasehold improvements usually belong to the landlord at the end of the lease. You are financing an asset you will not own, which is why lenders look hard at how long your lease runs.
- Match the term to the lease, not to the fit-out. Financing a build-out over seven years on a four-year lease is the same mismatch as over-financing a vehicle.
- Ask the landlord for a contribution. A tenant improvement allowance is normal in many markets and is the cheapest money in this project by a distance.
- SBA 7(a) can fund leasehold improvements, often alongside the equipment and the working capital in a single loan, which suits an opening.
- Equipment is usually better financed separately — see equipment financing — since the asset secures itself and you keep the fit-out borrowing smaller.
What to settle before you break ground
- A contingency in the budget. Ten to fifteen percent is normal. Projects that run over do so because something was not known, which is precisely why you cannot plan the overrun away.
- Who pays for inspections and draw fees, and how long each draw takes in practice.
- What happens if the contractor walks or the schedule slips past the loan term.
- Whether the lien covers only this project or everything you own — see blanket lien.
- The permanent financing, in writing, ideally from the same lender.
Questions people actually ask
How does a construction loan pay out?
In draws rather than a lump sum. Work is completed, inspected and then funded, with a portion retained until the project is finished. You generally pay interest only on what has been drawn so far.
Can an SBA loan be used for construction?
Yes. SBA 504 is often the best structure for building or expanding owner-occupied premises because it fixes the rate for the whole term with no balloon. SBA 7(a) can cover construction within a mixed-use project, and Builders CAPLines exists for contractors building for resale.
What is retainage?
A percentage of each payment held back until the work is complete and accepted. It protects against defects and unfinished work, and it means neither you nor your contractor receives the full amount as you go.
What happens when construction finishes?
Either the loan converts to permanent financing on terms agreed at the outset, or it falls due and must be refinanced. Find out which before you sign -- a construction-only loan is a refinancing obligation on a fixed future date.