A commercial construction loan finances the ground-up construction or major renovation of an income-producing property such as an office building, retail center, or multi-family project, and it releases money in stages as construction hits verified milestones rather than at closing. Underwriting is tighter than for a standard commercial mortgage because the collateral doesn’t exist yet: lenders typically want a debt service coverage ratio of at least 1.25 on the finished property, borrower equity of 20% to 35% of total project cost, a detailed line-item budget with a contingency reserve, and evidence you can actually deliver the building. The whole structure rests on one premise: the completed property will produce enough revenue to service the debt.
Choosing a Loan Structure
The structure you pick determines what happens on the day construction ends, which is often more consequential than the interest rate.
Construction-to-Permanent
A construction-to-permanent loan (also called single-close or one-time close) converts automatically into an amortizing mortgage once the property is finished and ready for occupancy. You close once, pay one set of closing costs, and lock permanent terms before breaking ground. For a developer who plans to own and operate the building long term, this removes refinance risk entirely.
Standalone Construction
A standalone construction loan covers only the build, typically 12 to 36 months. When construction is done, the full balance is due, and you either refinance into permanent debt or sell. It gives you flexibility to shop permanent terms once the building is producing income, at the cost of exposure to whatever the rate environment looks like when you need to close.
Mini-Perm
Mini-perm loans cover the build plus a four- to five-year runway afterward. They exist for the lease-up window, when the building is finished but not yet stabilized. That runway lets you fill the property and establish an income record before a permanent lender underwrites you on actual performance instead of projections.
SBA 504 and 7(a)
Small business owners have two federally backed options. The SBA 504 program finances new construction or major renovation of owner-occupied commercial property with a maximum loan of $5.5 million, and rates are pegged to an increment above the current market rate for 10-year U.S. Treasury issues.1U.S. Small Business Administration. 504 Loans The SBA 7(a) program covers real estate acquisition, construction, renovation, and working capital up to $5 million, with terms up to 25 years plus additional time to complete construction.2U.S. Small Business Administration. Terms, Conditions, and Eligibility Both require the borrower to occupy a substantial portion of the property, so neither works for purely speculative development.
What Lenders Require to Approve You
Debt Service Coverage Ratio
Most lenders want a DSCR of at least 1.25 on the finished property, meaning projected net operating income runs 25% above annual debt service. Some push to 1.30 or 1.35 for riskier property types or unproven markets. Your pro forma has to support the ratio convincingly, because the underwriter will stress-test your rent and expense assumptions against their own market data.
Loan-to-Cost and Equity
The loan-to-cost ratio caps the lender’s share of total project cost at roughly 65% to 80%. You cover the rest, 20% to 35%, as equity. Cash is preferred. Land you already own can sometimes count toward equity, usually at a discounted appraised value. The point of the equity requirement isn’t just protection for the lender; it’s a bet that a borrower with meaningful skin in the game will stay engaged through the cost overruns and delays that construction always produces.
Credit and Experience
Personal credit scores of 680 and above sit in competitive territory. Some lenders will work with scores in the 660s at higher rates. Experience matters almost as much: a first-time developer proposing a 200-unit apartment complex will face far more scrutiny, and often outright decline, than someone who has already delivered three similar projects on time. Bringing in an experienced general contractor or co-developer can offset a thin personal track record.
Liquidity Reserves
Lenders want liquid reserves beyond your equity, enough to cover several months of interest and unexpected expenses. Your construction budget should also carry a contingency reserve of 5% to 10% of hard costs. Running out of money mid-build is the scenario lenders underwrite hardest against, and applications without a visible cushion get declined.
Documents You’ll Need to Assemble
The application package is much thicker than for a conventional mortgage, because the lender is underwriting both you and a building that only exists on paper.
Business and Financial
Plan on providing a business plan that covers project scope, target market, and exit strategy; pro forma financials projecting income and expenses over three to five years; personal and business tax returns; balance sheets; and bank statements. For SBA-backed loans you’ll complete SBA Form 1919, which collects the business legal name, tax ID, business and project addresses, and detailed information about every owner with an equity interest.3U.S. Small Business Administration. Borrower Information Form
Construction
Lenders require a complete set of architectural plans and a line-item budget separating hard costs (materials, labor, site work) from soft costs (permits, legal, architectural and engineering fees). The construction contract with your general contractor must spell out scope, timeline, and payment terms. You’ll also submit the contractor’s resume, proof of bonding, and evidence of insurance. Every number in the budget has to reconcile with the construction contract; inconsistencies between the two stall applications.
Entity and Legal
Because most commercial construction runs through an LLC or similar entity, expect to produce Articles of Organization or incorporation, the operating agreement, and any partnership agreements. The borrowing entity’s name must match exactly across every document. A mismatch between the entity on the application and the entity on the land deed is the kind of detail that sends a file to the bottom of the pile.
Site Due Diligence the Lender Will Order
Phase I Environmental Site Assessment
Nearly every commercial lender requires a Phase I Environmental Site Assessment under the ASTM E1527-21 standard, which the EPA recognizes as compliant with the All Appropriate Inquiries rule under CERCLA.4Federal Register. Standards and Practices for All Appropriate Inquiries The Phase I reviews historical records, aerial photos, regulatory databases, and site conditions to identify recognized environmental conditions. Standard commercial properties typically run $2,000 to $4,500; industrial sites or properties near gas stations cost more. If the Phase I flags potential contamination, the lender will require a Phase II involving soil and groundwater sampling, which is significantly more expensive and can delay closing by weeks or months.
ALTA/NSPS Land Title Survey
Commercial lenders and title companies require an ALTA/NSPS land title survey that maps exact boundaries, locates easements and encroachments, and identifies setbacks and rights of way.5National Society of Professional Surveyors. Minimum Standard Detail Requirements for ALTA/NSPS Land Title Surveys Cost is typically $2,000 to $3,000 depending on property size and complexity. The results feed directly into the title policy and construction planning.
Builder’s Risk Insurance
Standard property insurance doesn’t cover a building under construction. Lenders require a builder’s risk policy with coverage equal to at least 100% of the completed value of the project.6Fannie Mae Multifamily Guide. Property and Liability Insurance The policy covers fire, weather, theft, and vandalism during the build. Premiums generally run 1% to 4% of total construction costs, with the range reflecting location, construction type, and coverage terms. The lender must be named as an additional insured, and proof of coverage is a closing condition.
Rates and How Interest Is Charged During the Build
Construction rates sit above permanent mortgage rates because the lender is taking more risk. As of early 2026, construction financing rates range from roughly 5.50% to 8.75%, depending on borrower strength, project type, and structure.
Most floating-rate construction loans are priced as a spread over the Secured Overnight Financing Rate (SOFR).7Federal Reserve Bank of New York. Secured Overnight Financing Rate Data A typical loan might price at SOFR plus 200 to 350 basis points, so your rate moves with the index. Fixed-rate options exist for the construction phase but are less common. When a construction-to-permanent loan converts, the permanent rate is usually benchmarked to the 10-year Treasury yield plus a lender spread.
You pay interest only on the amount actually drawn, not the full commitment. If your loan is $10 million and $3 million has been advanced, you’re paying interest on $3 million. Carrying costs stay manageable early, then climb steadily as each draw funds.
How Draws, Retainage, and the Interest Reserve Work
The Draw Schedule
Before the project starts, the lender approves a draw schedule tied to your budget and construction milestones. Typical milestones include site prep, foundation, framing, mechanical systems, and final finishes. To trigger a draw, you submit invoices from subcontractors, proof of payment for prior draws, and lien waivers from everyone who worked on the previous phase. Lien waivers confirm that subcontractors and suppliers have been paid and won’t file a claim against the property.
A third-party inspector then visits the site to verify that the work described in the request matches what’s actually built, checking both quantity and quality against approved plans and building codes. Only after the inspector’s report clears the milestone does the lender release funds, typically by wire to the borrower or directly to contractors.
Retainage
Lenders commonly hold back a percentage of each draw as retainage until the project is complete and the final inspection is approved. The traditional rate has been 10% of each progress payment, though many states cap retainage at 5% or require reduction once the project passes 50% completion. Retainage functions as a financial incentive for the contractor to finish and correct deficiencies flagged at the final walkthrough. It’s released after the lender confirms the project is complete, all lien waivers are collected, and any punch-list items are addressed.
Interest Reserve
Because the property produces no income during construction, many lenders build an interest reserve into the loan. It’s an account funded from loan proceeds at the first draw, debited monthly to cover your interest. The reserve is typically sized assuming roughly 50% of the loan balance is outstanding on average during the build, with the exact figure adjusted for how front- or back-loaded the draw schedule looks. If the reserve runs dry before construction ends, you’ll need to reallocate funds from another budget line, negotiate an increase to the loan, or cover interest out of pocket. Burning through the reserve early is one of the clearest signs a project is in trouble.
Closing Costs
Closing a commercial construction loan involves more parties, more documents, and higher fees than a residential closing, and these costs are due before construction money moves.
The appraisal is one of the first expenses. A commercial appraiser determines the “as-stabilized” value, meaning what the property will be worth once fully built and occupied. Commercial appraisals typically cost $2,000 to $4,000. The appraised value directly caps the maximum loan amount, so a low appraisal can force you to bring more equity or renegotiate terms.
Origination fees generally run 1% to 2% of the loan amount, which on a multi-million-dollar loan is a real number. You’ll also pay title insurance (lender’s policy sized to the loan amount), recording fees to file the deed of trust or mortgage with the county, and legal fees for the bank’s counsel to prepare the note, security agreements, and related documents. All in, closing costs commonly reach 3% to 5% of the loan amount. At closing, documents are signed and notarized and the deed of trust or mortgage is recorded. Recording establishes the lender’s priority lien, and the first draw funds once recording is confirmed.
Personal Liability and Recourse
How much personal exposure you carry depends on whether the loan is recourse or non-recourse, and even non-recourse loans have sharp teeth in the fine print.
A recourse loan lets the lender pursue your personal assets (bank accounts, investments, other real estate) if the collateral doesn’t cover the outstanding debt. Most commercial construction loans are full recourse, and nearly all require a personal guarantee from the principal. SBA loans require personal guarantees as a standard condition.
Non-recourse loans limit the lender’s recovery to the collateral itself. But virtually every non-recourse commercial loan includes “bad boy” carve-out provisions that convert the loan to full recourse if the borrower triggers certain events. Common carve-outs include allowing tax liens or mechanic’s liens to take priority over the loan, committing waste on the property, filing for bankruptcy, failing to maintain the property or the borrowing entity’s legal separateness, and making inappropriate distributions of project income when the property needs capital. Tripping a single carve-out can make the guarantor personally liable for the entire balance regardless of what the property is worth. Read the carve-out schedule with your attorney before signing; this is where borrowers routinely underestimate their risk.
Tax Treatment of Construction Interest
Interest paid on a commercial construction loan during the build phase is not deductible as a current business expense. Federal tax law requires interest costs allocable to the production of real property to be capitalized, meaning added to the cost basis of the building rather than written off in the year paid.8Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs The rule applies because real property has a “long useful life” under the uniform capitalization rules, and the capitalization requirement covers the entire production period from the date construction begins through the date the property is ready to be placed in service.9eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
You don’t lose the deduction; you defer it. Capitalized interest becomes part of the depreciable basis and is recovered over the applicable period (39 years for nonresidential commercial property, 27.5 years for residential rental property). Your accountant needs contemporaneous written records documenting production period estimates and cost allocations, because the IRS expects detailed support.
The Section 163(j) Election
Separately, Section 163(j) caps the amount of business interest you can deduct each year based on adjusted taxable income. Real property trades or businesses can elect out of the limitation, but the election is irrevocable and comes with a tradeoff: you must depreciate the property using the alternative depreciation system (ADS), which uses longer recovery periods and eliminates eligibility for bonus depreciation. For tax years beginning after December 31, 2025, the interest limitation is applied before mandatory capitalization under Section 263A(f), so capitalized construction interest is excluded from the limitation calculation entirely.10Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Whether the election makes sense depends on your overall tax position, so raise it with a tax advisor before closing.
When the Budget or Timeline Slips
Construction projects run over budget and behind schedule more often than not. What happens financially when they do is worth planning for.
If the interest reserve empties before construction ends, you have three options and none are painless: reallocate funds from another budget line (something else doesn’t get built), negotiate an increase to the loan (needs lender approval and often triggers new fees), or pay interest out of pocket (strains liquidity at the worst time).
If the loan reaches maturity before the project is complete, you’ll typically need to negotiate an extension. Extension fees generally run 0.25% to 1.0% of the outstanding balance, and the lender may require updated appraisals, financial statements, and a revised construction timeline before granting it. Approval isn’t guaranteed. If the project looks like it’s in serious trouble, the lender may instead move toward foreclosure or demand a large additional equity injection.
The contingency reserve in your original budget is the first line of defense. Set aside 5% to 10% of hard costs, and resist drawing on it for non-emergency expenses early in the project. Experienced developers treat contingency as money that doesn’t exist until something actually goes wrong, because on most projects something does.