What is construction finance?
Construction finance refers to the short-term loans available to construction goods suppliers, construction businesses, prospective homeowners, home builders, and home buyers. The finance enables them to buy supplies, settle expenses, complete construction of a dream home, real estate, new home building project, or renovate a residence.
Suppliers need financial assistance as they typically sell to contractors on credit because the construction industry is notorious for having the worst payment delays of any industry. On average, it takes three months before a construction company will receive payment.
Unlike homebuyers or an owner-builder, suppliers have no access to mortgage loans, end loans, permanent mortgage, FHA loans, home equity loans, adjustable rate mortgage, permanent loans, renovation loan, permanent financing, traditional mortgage, or other home construction loans.
Nonetheless, that does not mean there’s no way a supplier can access financing. If you are a supplier feeling the pinch from strained financial obligations, here are the construction financing options available to your business.
Why a construction company may need financing & net terms
Contractors usually have huge upfront cash obligations at the beginning of projects that burn through their initial budget. Problem is, most clients need general contractors to complete milestones before they can release further cash, and some may run out of cash before they do.
Further, contractors have pressing bills that need immediate settling, such as salaries and fueling.
As a result, most construction companies get supplies on credit to complete a construction project. That’s great for the contractors, but for the supplier, cash flow issues will begin to crop up. Suppliers too have operational costs to settle, and cash flow restrictions can cripple their business.
Construction financing options:
1. Business line of credit
In this arrangement, the lending institution lets your business borrow up to a specified limit. Your construction business can draw from this pool whenever needed. It works in the same way as a conventional credit card. The best way to utilize it is to resolve operating expenses such as payroll, construction costs, and supplies, because you are sure of incoming cash.
In short, if you have a credit line limit of $80,000, it means you can make any number of withdrawals up to $80,000. The great thing about a business line of credit is you only incur interest on the amount of money you have withdrawn.
To qualify, the financial institution will assess your debt-to-income ratio by scrutinizing your bank account information, personal credit score, and business financial statements.
With an unsecured line of credit, you do not need to provide any collateral, but this increases the risk to the lender. Consequently, your credit limits will be much lower, but have higher interest payments.
Secured line of credit provides higher credit limits and lower loan rates as the collateral assures the lender’s risk.
However, lines of credit generally have higher interest rates than regular bank loans, and it’s often in the same ballpark as credit card debt. Additionally, you would need to get your financial statements sorted and backed by a good credit score.
2. SBA loans
The US government-backed Small Business Administration (SBA)-guaranteed loans are a special kind of construction loans given to qualified small companies to help them sort out cash flow issues. Local banks will channel out funds to the small business, which the SBA guarantees.
There are three main types of SBA loans:
- SBA Express and Export express loans. As the name suggests, these loans take the least time to process, usually 24-36 hours, but they offer the smallest loan amounts at $350,000 to $500,000 respectively. Maturity period ranges from 7 – 25 years.
- SBA 7(a) loan should help your business cover working capital, refinance existing debt, supplies and equipment purchases, and sort out operational costs. Maximum loan amount is 5 million, payable within a maximum 25 years.
-SBA 504 loan is for property improvement, new construction, buying land, or long-term machinery/equipment. The loan ceiling is $20 million, payable within 10 to 25 years. Its interest rates can be the highest of SBA loans.
SBA loans can be as low as $500 to as high as $5 million at an annual percentage rate (APR) as low as 6.5%. Repayment periods can run up to 25 years, but they typically run 10 years.
To qualify, you must operate in the US, operate a for-profit business, hold investment equity shares in that business, and must have exhausted all other financing options. There’s plenty of paperwork involved, and you must meet the SBA’s size standards, which are dependent on your annual revenue. Some SBA loans may require collateral and down payment.
3. Short-term loans
If you secure a short-term loan, construction loan lenders will expect repayment within 1-3 years. It is an excellent option for start-ups and smaller businesses that cannot qualify for a line of credit or other types of loans.
Although the interest rates and loan amount will vary across lenders, they are usually smaller amounts with higher interest rates than standard loans. Interest rates range from 8-13%.
The great thing about short-term loans is the speed of approval, which is great for sorting out a financial emergency. Small amounts are involved, so you can secure one through online application, approved within a day.
However, you may still have to produce your bank statements, credit score, and personal or business tax returns, and the lender may require you to make weekly repayments.
4. Digital net terms
Another way you can ensure a steady flow of cash is to offer net terms. In such businesses involving great amounts of money, it’s not reasonable to expect all customers will pay in cash. That’s where net terms come into play.
In this format, you can give your customers a grace period within which to pay the invoice in full. That means you can plan your expenses around expected payments period without placing unnecessary pressure on your customers. Net terms generally refers to a deferred payment timing of 30, 60, or 90 days.
That all seems like a great idea, but we all know that however generous your terms are, some customers may still not pay on the due date, throwing your cash flow plans into disarray. Resolve may have a solution for you.
Resolve offers digital net terms management, and it’s the answer to all your net terms payment issues. They offer a smart credit engine that does a credit check on your customer to assess their creditworthiness. The simple and fast check will confirm their suitability for credit line and net terms.
Once a customer approval is complete, Resolve will categorize the customer according to risk profile, and approve an advance rate of 50%, 75%, or 90%. They will then advance you up to 90% of the invoice, within 1 day.
When the invoice is due, Resolve has a payment chaser product that makes the payments collection process painless. By automating the payment reminders and collections, you don’t have to look like the bad guy as Resolve will do all the chasing. Your customers also get access to a neat payments portal that accepts payments in ACH, check, and credit card.
5. Merchant cash advance
As for merchant cash advance (MCA), the lending company will send you advance payments pegged on future sales. They will require you to make an undertaking to give them a cut on you future sales, while paying additional fees.
Technically, this is not a loan but a purchase of future sales. The cash advancer will send you the lump sum amount and will deduct their due from your account as cash trickles in, or through credit card processing. As you’ve probably guessed, it is a risky undertaking, raising the interest rates.
Providers do not apply stringent qualifications as businesses with little collateral and low credit score can still acquire an MCA. An MCA provider will confirm if you have enough sales volume by perusing your bank statements and credit card statements, since they get their payments through credit and debit card sales.
MCA approval times happen within 2 days, but repayments will eat into your daily sales. Seeing as the MCA industry is unregulated, a provider can impose punishing interest rates and daily payments.
6. Business term loan
This is the conventional bank loan that most people refer to when discussing a business loan. When you take a business term loan, the lender will send you a lump sum of money which you will repay over an agreed period.
Loan repayments vary between 1-5 years, and the provider will generally require monthly repayments of the principal term and interest.
The good thing about business loans is the high credit limit and low-interest rates. Business term loans are great if you need a predictable loan as they feature fixed rate and fixed term repayments.
Still, you will often have to provide collateral and have a great credit score. The loan officer will evaluate your business and personal tax returns, annual business revenue, and it will take some time before the lender approves the loan.
Another downside to business term loans is the prepayment penalties. The provider will impose penalty fees for repaying the loan before the loan term ends. Therefore, they are not a great option if you are looking for a short-term financing solution.
7. Invoice factoring
When your company has an unhealthy accounts receivables, a quick way of improving cash flow is invoice factoring. You receive the cash as soon as you’ve issued the invoice, sidestepping the long delays before payment.
One good thing about this type of financing is invoice factoring is not a loan. You sell that invoice to the factoring company for up to 90% of its value and then pay the factoring rate, which is usually between 1-5% per month in the construction industry.
Resolve is the modern version of factoring, but it offers much more than conventional invoice factoring, and it’s cheaper. Issuing net terms to customers might seem a simple task, but an estimate states that businesses in the US lose about $65 billion yearly to check fraud alone.
With the Resolve solution, you don’t need to take in any of the risks associated with other invoice factoring companies. Resolve will conduct all the legwork, carrying out comprehensive credit checks within minutes and without requiring you to fill in any paperwork. What’s more, you will not have to make monthly payments with Resolve.
Not a fan of the long wait times before the factoring company releases the cash? Resolve will have it ready within one day of invoice approval. Are you tired of the huge fees and hidden factoring charges? Resolve lays everything bare from minute one. But factoring services leave the invoice non-payment risk to the borrower? Not with Resolve. Once you receive our payment, you can wash your hands from that transaction as we assume non-payment risk henceforth.
8. Business credit card
A business credit card works in the same way for a business as your credit card does for you. The business credit card provides short-term construction finance, like the normal line of credit.
Like the line of credit, the lender sets a loan limit, which your business can borrow and repay repeatedly.
Unlike other forms of line of credit, a business credit card is always unsecured, comes with annual fees, lower credit limits, and higher repayment rates.
For you to qualify, you need to sign a personal guarantee to take personal responsibility for the debt if the business fails to pay the business credit card bills.
Additionally, the creditor’s appraiser will analyze your personal credit score, which will have to surpass a set threshold before they can approve the facility. To determine your credit limit, the creditor will scrutinize the business annual revenue.
9. Accounts receivable financing
This is another form of asset-based financing where the lender gives your business a loan using outstanding invoices as security. Normally, they will issue a loan that’s 80-90% of the value of the invoice.
The lender gets their money back by deducting fees according to the length of time it takes your clients to pay the invoice in full.
Qualifying for the loan is not that difficult as all the lender needs is to ascertain that you supplied the goods and the customer is a reputable firm. For that reason, whether you get the loan or not does not entirely depend on your creditworthiness, but the credit ratings of your client.
That said, the lender would require you to have been in business for at least half a year, and generated at least $50,000 in revenue.
With this type of loan, processing times are short, the invoices act as collateral, and you don’t need great credit scores.
On the other hand, it is more costly than other short-term options such as line of credit, and you will be liable if the client does not pay.
To sum up, if you have a construction business with cash flow issues, contact Resolve today. They will give you a demo showing how their peerless services can help your business get out of a financial hole.