Construction projects are expensive, and it’s hard to turn a profit if you are just starting out. Construction loans are good options for contractors who need cash to complete a job or expand their business. One of the benefits of construction loans is the fact that the interest rates may be tax deductible. Since borrowed money is treated as ordinary income, the interest you pay on the loan is deductible on your taxes and potentially lowers your taxable income. Applying for a construction loan can also help you build your credit score, since most lenders require you to provide proof of income to qualify. When you are ready to apply for your loan, network with other business owners in the construction industry to get a recommendation.
Here are some things to consider when looking for general contractor financing.
What is contractor financing?
Contractor financing is a loan that a contractor takes out to fund their business. It is typically unsecured and uncollateralized (cannot be pledged as a barrier to repayment). The lender in this case is usually another contractor or construction company, rather than a bank, so rates are generally lower than traditional bank loans.
This loan can be used to pay for expenses related to construction, whether it’s materials, labor, equipment rental, or general operating expenses.
Home improvement financing
Home improvement loans can be used for a variety of projects, including renovations and repairs. They can also be used to fund the purchase of new tools and equipment for your business.
Home improvement loans are unsecured, meaning they don’t require any collateral (like your house). As such, they are generally more expensive than secured loans. The good thing about home improvement loans is that they tend to have lower interest rates than traditional business loans. They also have more flexible terms than business loans, often allowing larger loan amounts.
Trade credit is similar to credit card financing in that you don’t have to pay interest or repay the principal until some time after the work has been completed. However, most contractors and construction companies prefer trade credit because it doesn’t impact their cash flow as severely as a loan would.
Trade credit is a line of credit you can tap whenever you need cash and pay back later. Unlike a business loan, you don’t have to come up with a deposit upfront to qualify for a trade credit account.
Line of credit
Line of credit (or trade credit) is the best way to get financing without a long-term commitment. Ideally, you want to shop around and get the line of credit with the lowest interest rate, the most flexible terms, and the best repayment schedule to satisfy your business needs.
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Project cost financing
Is a type of contractor financing that is used to cover the cost of projects before they are completed. It may start off as a simple loan, but it can become a long-term line of credit if demand is higher than cash flow.
A project cost line of credit might be structured as a secured loan with collateral, like a home, or as an unsecured line of credit. Some contractors use equity in their home for project cost financing to avoid putting all of their borrowing power into their business.
Business credit cards
Business credit cards are a quick and easy way to get financing for your construction company. Some cards offer 0% APR for purchases and balance transfers for up to 18 months, while others offer rewards like cash back or points that you can redeem towards free travel.
Business credit cards come with high interest rates and fees, so it’s important to read the fine print and compare offers from several different providers to find one that works for you.
Business banking loans are generally reserved for established owners and business owners seeking to expand their business. As a result, small-business loans have stricter criteria than personal banking loans. To qualify for a business banking loan, you will need good credit, solid business and personal financial statements, and proof of your work experience in the industry. Business banking loans are usually smaller than home improvement loans and project cost loans because they don’t require as much collateral.
Invoice factoring is an alternative to getting a loan to pay for construction expenses or expand your business. An invoice factoring company purchases your invoices at a discount, which frees up cash for you to send to your customers. Invoice factoring is more expensive than traditional trade credit, but it often has a faster turnaround when you need cash right away. Some factoring companies even offer up to 90% of the value of your invoices.
Equipment financing is a great way to get cash if you need to invest in new equipment for your business. Equipment financing differs from other types of business loans in that it doesn’t require a down payment or collateral (like your home or equipment) to qualify. In fact, there is no lengthy application process for equipment financing options. You simply need to complete a short online form, and a dealer representative will follow up with a phone call to discuss your loan options.
The risk & cost of contractor financing
Construction projects can fail for a number of reasons – weather affects, problems with subcontractors, etc. Whatever the problem, you must pay your creditors. If you decide that a project is unprofitable and no longer worth completing, you will have to refund client deposits (or pay them back) and cancel your contracts with subcontractors. You may also have to repay the general contractor loan in full, so doing proper due diligence is crucial.
How to qualify for better financing
There are several ways you can reduce your risk and improve the lender’s perception of your creditworthiness. In practice, this means that you pay less to borrow and get better interest rates.
- Be organized: This point applies both to your finances and your paperwork. Every dollar counts on construction projects and it is crucial to save money wherever possible. To save money, send invoices promptly and follow up on late payments.
- Build relationships: Talk to other business owners in your trade. Ask them for recommendations if you need a lender. Talk about your credit history and ask about the interest rate on their current loans. You may be able to get better rates on better terms if you are connected to someone who has good credit with your current lender.
- Do your homework: Before taking out a loan, research the lenders in your area and talk to friends in your industry. Make sure you know what kind of financing you need and what the terms of the loan will be. If you do this properly, you can save money and reduce the risk associated with financing.
- Use credit wisely: Having enough cash on hand is important when dealing with construction lenders and projects. However, try to maintain a healthy mix of cash and credit in your business. Having sufficient cash flow ensures that you have a cushion if a project runs into problems or you need to finance another project quickly.