When looking for a small business loan, the SBA 7(a) loan is one of the U.S. Small Business Administration’s (SBA) most popular loans, especially when your project includes the construction or renovation of a new facility. Sometimes, your project will need an additional, short-term construction loan to cover the construction or renovation period.
This additional step can cause a lot of confusion, so in this guide you’ll learn when and why a separate construction loan may be necessary.
How is the SBA 7(a) loan used for construction and renovation projects?
The SBA 7(a) loan program has financing from $50,000 to $5 million for startups and established small businesses in any qualified industry. You can use the funds for a wide range of expenses. This can include purchasing commercial real estate, leasehold improvements or renovations, purchasing furniture, fixtures, and equipment, inventory, working capital, and more.
Another great feature is that you can use the funds from a single SBA 7(a) loan for several of those needs – even when a portion of the loan will cover construction or renovation.
If you need financing for construction or renovation, you can also work out an interest-only period during the construction period and sometimes for an additional period of time after it’s completed. Lenders know that your ability to generate revenue during and just after construction may be limited, so the interest-only period will significantly reduce your payments.
When do you need an additional construction loan?
Although lenders will often approve the SBA 7(a) loan to cover all aspects of a project, there are cases where you’ll also need to secure an additional loan to cover expenses received during the construction period. This may be the case when your project is very large, complex, expensive, or specialized, and presents a higher level of risk to your lender.
In these cases, a construction loan is used to cover construction-related expenses. When your project is completed and approved by your lender, then the construction loan is paid off in full through SBA 7(a) disbursements.
With a construction loan, your lender will most likely require interest-only payments for the construction period. This helps you get the financing in place to move your project forward while reducing your financial stress. However, the option to have an interest-only agreement is up to the lender, so be sure to consider this if you need a construction loan. Construction loans may also have a slightly higher interest rate.
It’s important to know from the start of the application process whether a construction loan may be required – your lender should guide you during the early part of your application process. Here are some examples to demonstrate whether you’ll need an additional construction loan:
1. When your project would likely require only an SBA 7(a) loan
You have approached a lender about a restaurant that you want to lease for your business. It was previously a takeout-only location, so you need financing to expand the kitchen, add guest bathrooms, and convert some of the space into a bar and dining area. The renovation will take two months and cost $150,000, with one month of downtime to equip the space and get it ready for opening. You’ll also need another 2-3 months after opening to generate sufficient cash flow.
You are seeking SBA 7(a) financing of $280,000, including the cost of the renovation, working capital, and furniture, fixtures, and equipment (FF&E). You are also requesting a six-month interest-only period.
Given the straightforward work, timeline, risk, and cost, your lender would likely approve this project using only the SBA 7(a) loan financing.
2. When your project would likely require a construction loan
You want an SBA 7(a) loan of $4 million that covers the ground-up construction of a small manufacturing facility. Of that loan amount, your plan has $3 million for all costs related to construction, including addressing environmental concerns from the land’s previous use. You have detailed reports and estimates from environmental engineers, architects, and a construction firm. The full construction project is expected to take nine months to complete.
Once the project is complete, you will use the remaining SBA 7(a) funds to purchase equipment and for working capital, including purchasing the materials needed to make the products, support marketing efforts, and to hire and train staff.
Given the higher level of risk involved – the environmental issues, the longer timeframe, and the higher cost of the project – your lender would likely require a construction loan.
What are the benefits of using a construction loan?
Although the construction loan is an additional step in the process, you gain the benefit of having increased oversight on your projects from engineers and architects who are approved by your lender. While this happens because it helps your lender ensure that the project financing is running on time, and on budget, this can give you some peace of mind as well.
How to determine if you need a construction loan
Here are the steps to see if your project can be accomplished solely through an SBA 7(a) loan or if you’ll need an additional construction loan:
- Before you begin the application process, talk with your lender about your project’s end goal. Give as many details as possible, including detailed plans like architectural renderings or blueprints, cost estimates, and anything else that will help your lender determine your financing needs, timeline, and level of risk involved.
- Your lender will use the information you provide to decide whether your project could be approved with a single loan through the SBA 7(a) program or if your project will need a construction loan.
- If your lender determines that an SBA 7(a) loan can be used to cover the entire project, then you’ll only need to secure one loan and work with your lender to set the interest-only period, if needed. However, if your lender decides that you’ll need a construction loan, either your lender can get you the separate construction loan or you can contact different lenders to provide this financing.
Although the need for a construction loan can be an additional and daunting step if you’re not prepared for it, with this information, it’s easy to see it simply as a short-term necessity that can have additional benefits for your project.
Whatever your needs, Pursuit can help
Whether you need financing for a straightforward renovation or a higher-cost construction project, the SBA 7(a) loan program can be a great option – and Pursuit can be the lender that helps bring your vision to life. We offer more than 15 financing options from $10,000 to $5.5 million, including loans and a line of credit for businesses in New York, New Jersey, Pennsylvania, Connecticut, Nevada, Illinois, and Washington.
Contact us to learn more.
