The U.S. construction industry has been booming and is expected to continue strong growth, reaching $1,650,159.2 million by 2026. However, it’s also not without challenges.
Construction business owners are dealing with supply chain disruptions. high insurance rates, a long list of licensing and permit requirements, and expensive material and equipment costs. These can lead to cash flow issues, which make it difficult to cover invoices on time, pay employees, and purchase the tools you need to succeed.
That’s where a construction line of credit can be invaluable to home builders, general contractors and others in the construction business.
What is a Construction Line of Credit
With a construction line of credit, you’ll be approved to borrow up to a certain amount. You can access some or all of the line of credit as needed. It offers a flexible type of short-term financing. Some lines of credit are secured by collateral, but many times these are unsecured loans. Unsecured loans carry higher risk for the lender and interest rates often reflect that risk.
What is the Difference Between a Line of Credit and Construction Loan?
A construction loan offers a fixed loan amount, usually for a specific purpose (i.e. a to finance a specific construction project). You’ll often pay a fixed rate of interest on the loan, and payments are often fixed for a period of time. Small business loans offer repayment periods ranging from one year, up to twenty or even twenty-five years for some commercial real estate loans.
A line of credit is a more flexible option. Your business will be able to draw from the line of credit as needed and will only be charged interest on the outstanding balance. Payments will vary, depending on the outstanding balance. Some lines of credit require interest-only payments during a draw period; the balance will need to be repaid later which may mean higher payments (and no access to the line of credit during that time.)
Requirements for Construction Lines of Credit
To qualify for a business line of credit for your construction business, lenders will often consider the following factors:
- Credit History: A lender may check a prospective borrower’s personal credit, business credit or both. Larger, well-established businesses with significant revenues may be able to avoid personal credit checks if other qualifying factors are strong. But don’t be surprised if one is required.
- Time in Business: New businesses (less than two years old) will have fewer options, especially when it comes to traditional financing options like bank lines of credit. The lender may be more flexible on this factor if the business owner can demonstrate extensive industry experience.
- Revenues: A lender will want to verify business revenues to ensure the business can repay the loan. You’ll likely be asked to provide proof of monthly revenues with business bank statements. Some lenders may also require 2—3 years of business tax returns. In addition, the lender may analyze the businesses’ financials, looking at metrics such as the Debt Service Coverage Ratio or Debt to Equity Ratio.
Some lenders will require a personal guarantee, or will file a UCC filing. Make sure you understand what types of guarantees or liens will be required.
Benefits of Construction Business Loans
Construction lines of credit and construction business loans may be used for a variety of business purposes, not just construction costs. Here are several ways they can benefit your business:
Cash flow is often a challenge in the construction industry. That’s especially true in the current environment where costs have been rising quickly and significantly. A construction line of credit can fill the gap and ensure you have enough cash to handle all of your expenses year round. It can be particularly beneficial if you’re going through a slow sales cycle due to the weather, industry trends, or the economy.
Construction equipment is expensive, to say the very least. However, it’s a necessity for any construction business. A construction line of credit can be used to buy equipment at a discount until other financing can be lined up. Equipment loans and financing can also be a good choice here.
Your crew is the lifeline of your business. You may have the highest quality equipment but if you don’t have enough contractors or hire the wrong ones, things can go south very quickly. A construction loan can give you the opportunity to hire more contractors or invest in those with more training and experience.
Ultimately, this type of financing will give you more flexibility in your business. You can spend more time getting work done, rather than trying to find financing or worrying about juggling expenses.
However, you want to keep in mind that a line of credit is borrowed money. You should always understand how you’ll leverage those funds to make more money in your business.
Additional Funding Options for Construction Business
If a line of credit isn’t a good fit, consider these alternative funding options:
The Small Business Administration (SBA) partners with banks and other lenders to help small business owners obtain funding. If you opt for an SBA loan, you’ll enjoy a number of benefits including longer loan terms, interest rate caps, and low down payment requirements.
There are several types of SBA loans that may be used for working capital, equipment and real estate. SBA loans for real estate have owner occupancy requirements, however.
Equipment loans and leasing can help you acquire the financing you need to grow your construction business. Because the equipment serves as collateral, it may be more flexible than other types of traditional financing.
If you have good credit and don’t need the cash right away, a bank loan may be the way to go. While the application process can take weeks or months, you may be able to lock in a low interest rate that leads to affordable monthly payments.
Most banks offer both short-term financing and long-term financing loans so it’s a good idea to shop around and find the ideal loan for your unique needs. When you explore your options, you’ll likely find that big banks have rigid lending rules while smaller ones offer greater flexibility.
Business Credit Cards
A business credit card works just like a personal credit card. You can spend as little or as much as you’d like up to a certain credit limit. You’ll only pay interest on the amount you borrow. Most business credit cards come with cash back or points programs that can reward you for your spending.
Additionally, some of them offer 0% intro APR offers where you won’t owe any interest for a certain period of time. Although your credit history will determine the credit limit you receive, you may be able to secure tens of thousands of dollars in credit.
Home Construction Lines of Credit
We’ve focused on construction lines of credit for businesses. However, homeowners may need to secure a construction loan in order to fund the construction phase of building a new home. These loans are usually short-term loans that fund construction costs until permanent financing can be secured. Homeowners may have several options when it comes to these types of home loans.
- New Construction Loan: A new construction loan is a short-term financing option that can allow you to borrow capital to buy a lot, cash out on a lot, or build a new home to sell.
- Construction-to-Permanent Loan: With a construction to permanent loan, you can receive the funding you need to cover the construction costs of a home. Once the home has been built, the loan converts into a traditional mortgage.
- Renovation Construction Loan: If you’re buying a fixer upper to fix up and eventually sell, you may choose a renovation construction loan. This type of loan wraps up the cost of any renovations you plan to make with a mortgage.
Construction loans will often carry higher interest rates than traditional mortgage rates. That’s because there is no completed property to serve as collateral for the loan.
Nav’s Final Word: Construction Line of Credit
A construction line of credit or a general business line of credit is a valuable financial tool that can help you build and grow your business. You can use it to secure the capital you need to pay for equipment and materials, hire more contractors, and manage cash flow.
If you decide to get a business line of credit, Nav can help. Nav makes it easy to get connected to the right financing options for your business.
This article was originally written on February 4, 2020 and updated on February 2, 2023.