The process of arranging for and negotiating construction loans can be more complex than many developers realize at the outset. The terms of the loan itself can impact not only the developer’s access to cash during the project and payments required during the life of the loan, but also the cost of the loan and the ramifications of default or unexpected adjustments. In addition, construction lenders often require a takeout commitment from another lender, meaning that there is another whole set of terms to resolve in advance of settling the construction loan. Typically, these requirements will be stringent as the lender will want to ensure that the letter represents a true commitment and does not allow the takeout lender to easily bow out of writing the loan.
Working with a commercial lawyer experienced in the organization and negotiation of construction loans and takeout commitments will help ensure that your interests are protected at every step, and that you are not unwittingly agreeing to terms that might hinder the progress of your project.
Key Terms in Construction Loans
Because a construction loan is integral to the operation and success of your project, the specific terms can be critical to your progress. It is important that you understand how the terms will impact your project and that you have a knowledgeable advocate to negotiate key points for you.
Construction Loan Fee: Construction loans typically involve two separate charges–interest and a construction loan fee. The fee is calculated on a percentage basis using the full loan amount, but payable at closing, at a time when only a small portion of the proceeds are likely to be disbursed.
Interest Rate: Interest rates on construction loans tend to be higher than on other types of loans, both because of the risk involved and because they are relatively short-term. They are often adjustable and may be tied to the prime commercial loan rate, but may also use another rate as a benchmark.
Interest Payments: Under the terms of some construction loans, the borrower must make monthly interest payments. Other agreements create an interest reserve that pays accrued interest from the proceeds of the loan, allowing the borrower to focus on construction without generating income in the short-term. Interest payments are less expensive in the long run, while the reserve fund reduces the burden on the borrower during the course of the project, so which is more beneficial depends on the specific situation.
Draw Systems: Unlike conventional loans, the proceeds of a construction loan are paid out over time. These payments, called “draws,” may be at set intervals (most commonly monthly) or tied to project benchmarks. The draw system can be critical to the efficient running of the project, since it impacts the loan proceeds available to the borrower at each stage of construction.
Bonding Requirements: Most construction lenders require both performance and payment bonds. The lender may or may not be listed as an obligee on the bonds. Often the lender will require that it be listed, as that role offers more control in the event of a default.
Reporting Requirements: Depending on the state and the lender’s practices, different types of reports may be required, sometimes as often as monthly. These may include summaries of expenditures, title updates and inspector’s reports, among other possibilities.
Not fully understanding the terms of a construction loan or having the power to negotiate for the terms most favorable to your project can leave you at a disadvantage–not just in terms of fees and interest rates, but in practical ways that may impact the success of your construction project.
Get Guidance from an Experienced Construction Loan Attorney
When you work with an experienced construction loan attorney like the ones in our office, the lawyer can guide you through the process from beginning to end, helping to ensure that:
- The terms of your construction loan will allow you to operate efficiently as you proceed with construction
- Your takeout commitment letter satisfies the construction lender’s requirements
- The terms of the takeout loan are favorable to your business
- You understand exactly what is required to comply with the terms of your loan and receive draws on schedule
- You have factored in the cost of and know how to secure any necessary bond
In short, we will put our legal expertise and commercial lending experience to work to ensure that you choose the option that is best for you; we will negotiate for the terms that matter to you, your business and your project. Contact KPPB LAW for more information.