When unpaid invoices leave your construction company in a cash flow quandary, where do you turn to get the money you need to invest in your next project or pay off business expenses? For many contractors, the immediate answer is to seek out a bank loan. This is definitely an option, and for some, it may be the right one. For others, however, it may prove too time-consuming and complicated to be feasible for their needs.
If you’re unsure whether or not a bank loan is the right path for your construction business, consider the process you’ll need to undertake in order to secure your loan. This includes a lengthy pre-approval process before the bank even decides to move forward with full underwriting procedures.
Let’s take a look at an overview of the pre-approval and underwriting process to see if a bank loan is the best choice for your construction company.
The Preliminary Steps to Getting a Bank Loan
Before you even begin the process, you’ll need to sit down with your lender to discuss the current interest rates and all loan policies such as Loan-to-Value Ratio (LTV) and Debt-service Coverage Ratio (DSCR).
You may need to submit preliminary documentation at this time such as a pro forma, although the lender may construct their own pro forma based on their own criteria. They may also request some basic numbers like your credit score (many banks look for a minimum FICO score for a construction loan of 580 but most like to see a credit score of at least 660.) At this point, the lender will likely need to have a private discussion with a senior advisor before agreeing to move forward with the process.
Typical Documentation Required for Construction Loans
After getting pre-approval from their team, the bank will require you to supply certain additional documentation such as:
- Profit & Loss (P&L) statements for several years and YTD
- Balance Sheets
- Cash Flow Statements
- Booked Backlog
- Aging Accounts Receivables and Payables
- Guarantor’s Tax Returns
- A Schedule of Owned Assets (equipment and real estate)
- Contingent Liabilities for the Guarantors
- Any other documentation that can support the loan request
These are only the typical documents banks require. Your lender may ask for additional pieces of information.
Other Things Banks Consider
In addition to the documentation, your bank will also need to evaluate the overall industry market and local market conditions. As banks consider construction a high-risk industry, they may dig deeper into your operational history and management team.
How Much Will The Bank Loan My Construction Company?
Once the necessary documentation has been submitted, reviewed, and approved, the bank will then use the calculated Net Operating Income, LTV, and DSCR to conduct a Maximum Loan Analysis. The maximum loan amount your company can support will be determined based on these calculations.
How Long Does It Take to Get A Construction Bank Loan?
When obtaining a construction loan from a bank, the time it takes can vary dramatically:
- Bank’s internal pre-approval discussion: Banks are pretty good at spotting red flags. If a construction company is a viable candidate they will usually tell you yay or nay that same day, though they might take a few days.
- Gathering the required paperwork: Of course, since you will be collecting all the necessary documents the time required for this step depends on your availability and organization, typically ranging from a few days to a few weeks.
- Submitting the loan application: Once you have gathered all the required paperwork, you can submit your loan application to the bank. This step usually takes a few days, but it may vary depending on the bank’s workload and internal processes.
- Underwriting and approval: The bank will review your application, evaluating your project, financials, and creditworthiness. This underwriting process typically takes several weeks. Additional documentation or clarification may be requested during this stage.
- Closing and disbursement: If your loan application is approved, you will move on to the loan closing stage. This involves signing the loan agreement and completing any remaining paperwork. After closing, it may take a few days to a couple of weeks for the bank to disburse the funds.
The entire process of obtaining a construction loan from a bank, including gathering paperwork and the time before and after approval, can range from several weeks to a couple of months. Of course, these timelines can vary based on your specific circumstances and the efficiency of everyone involved.
Why Banks Don’t Like Giving Construction Loans
At first, a bank loan might seem the obvious solution to a cash flow problem, but if you have experienced tough times getting approval will be nearly impossible. Yes, gathering the required paperwork and the wait can be frustrating, but the biggest hurdle might come down to something you can’t control. The person making the decision to loan your business money will often want the “safest” for the bank, not wanting to take any risk. Here are a few reasons why banks may be hesitant or cautious:
- Complexity and uncertainty: Construction projects can be complex and involve multiple parties, including contractors, subcontractors, architects, and materials suppliers. There is often uncertainty regarding construction timelines, cost overruns, and potential delays. Banks need to assess the feasibility of the project and ensure that it will be completed successfully.
- Higher risk: Construction loans are considered riskier compared to other types of loans. There is a higher chance of cost overruns, delays, or construction-related issues that could impact the repayment ability of the borrower. Banks must carefully evaluate the borrower’s financial strength, construction experience, and the project’s viability.
- Collateral challenges: Unlike traditional mortgage loans where the property serves as collateral, construction loans typically involve lending based on future value. This can make it difficult for banks to assess the value and marketability of the property during the construction phase.
- Market conditions: Banks are influenced by prevailing market conditions. During economic downturns or periods of uncertainty, banks may be more cautious about lending for construction projects due to the potential impact on the volatility of property values and the demand for new construction.
- Regulatory requirements: Banks must comply with strict regulatory guidelines, including capital reserve requirements and risk management standards. Construction loans may require more capital allocation and involve additional compliance measures, making them less attractive to some banks.
If you need a loan solely to pay off a few unpaid invoices, the right solution for your company may be found elsewhere.
What to Do When a Bank is NOT a Good Fit
There are easier and faster ways to get the cash when getting a bank loan is not a good fit. Invoice factoring might be an option. Designed to help you get a temporary cash flow boost, factoring can quickly help you keep your business running by purchasing your invoices, and giving you up-front cash while the factoring company waits for the payment.
Construction factoring can often get you up to 80% of your invoice amount within 3-4 days. But how do you know if factoring is better than a bank loan for your construction company? Give us a call or contact us. We can walk you through your financing options… whether it is factoring, spot financing, or any other of the available cash flow-producing options for you.
Related Reading: Pre-purchased Construction Materials – Saving Both Time and Money
Article Sources:
- Investopedia. “Loan-to-Value (LTV) Ratio: What It Is, How to Calculate, Example, https://www.investopedia.com/terms/l/loantovalue.asp”
- Investopedia. “Debt-Service Coverage Ratio (DSCR): How to Use and Calculate It, https://www.investopedia.com/terms/d/dscr.asp”
- Financially Simple. “How to Build Pro Forma Financial Statements That Wow Investors, https://financiallysimple.com/how-to-build-pro-forma-financial-statements”
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