Contractor Financing: The Complete Guide

The financial success of a construction business depends largely on its ability to manage cash flow. Throughout a project, contractors face a significant outlay of cash for materials and other needs — but months often pass before they ever see income from the project. As a result, many contractors turn to financing to pay for project expenses to cover their costs until payments begin rolling in.

Banks and other traditional lenders often consider construction too risky to finance. So how can contractors get cash to pay for materials, equipment, and other project expenses? In this guide, we will explain all of the options for contractor financing, including the pros and cons of each.

What is contractor financing?

Contractor financing describes the variety of financial options construction businesses can use to improve cash flow. These options can either provide a contractor with advance funds or allow them to defer payment for expenses.

In construction, the collection cycle can take weeks or months (not counting retainage, which could take years). Yet contractors pay for labor, materials, equipment, and more well before they collect the funds necessary to cover their costs. 

In other industries, many businesses can finance their operations through traditional financial institutions, often with low interest rates. Unfortunately, because of the financial risk inherent to the building industry, construction companies often have a harder time accessing traditional funding sources. 

Types of financing for contractors

In recent years, companies have begun offering a wider variety of financing options built for contractors. These can provide a lifeline to contractors who need capital to grow their business, take on larger projects, or fill predictable gaps in cash flow.

Trade credit

Trade credit is one of the longest-running financing options in construction, through which material suppliers and distributors allow contractors to purchase materials without any cash upfront. Repayment terms are typically 30 or 60 days before interest charges or late payment penalties are incurred. 

The application process typically requires the contractor to complete a credit application, and the supplier’s credit manager will often ask for financial statements and trade references. If the applicant doesn’t have sufficient credit history or references, suppliers may still offer credit to contractors willing to sign a personal guarantee or agree to a UCC lien. 

Pros: 

• Get credit directly from the supplier or distributor
• Typically interest-free when repaid within the repayment window
• Can use a variety of credit tools to approve customers
• Suppliers have a vested interest in maintaining a strong business relationship

Cons:

• Short repayment window often ends before contractor gets paid on the job
• Low credit limits
• Lengthy credit application process
• May require a personal guarantee or UCC lien
• A missed payment could end your relationship with the supplier 

Line of credit

A bank line of credit is a financial vehicle you can draw money from as you need it. You can withdraw and pay back the money as many times as you want, and interest only accrues on the amount that you withdraw. 

A line of credit can either be secured or unsecured. An unsecured line of credit will carry a higher interest rate because it’s not guaranteed by any collateral. A secured line of credit typically comes with a higher credit limit and a lower interest rate because the lender can seize your assets if you don’t pay back the money you withdraw.

Pros: 

• Provides money only as you need it
• You only pay interest on the amount you borrow
• You can withdraw and repay the money as many times as you need

Cons: 

• Has a higher interest rate than a traditional business loan
• Requires strong financial statements 
• Requires good credit 

Project cost financing

Today, more lenders are providing financing to contractors to pay for job costs up front with repayment terms that match the project billing cycle. These lenders often work exclusively with the building industry, so they have a deep understanding of the nature of a contractor’s business. This can often make them a valuable project partner, not just a financial resource. 

For example, materials often make up 20-50% of a contractor’s total project costs. Rather than paying in cash or maxing out a line of credit, the contractor can finance the entire material purchase through a third-party provider. The provider pays the supplier directly, and gives the contractor extended repayment terms — up to 120 days. The contractor makes small weekly or monthly payments until they receive payment from their customer and can repay the full amount. 

This type of financing is especially helpful when contractors are growing their businesses or taking on bigger projects. It can be used in tandem with other types of financing, like trade credit. If a contractor hits their supplier’s credit limit, they can use material financing to take on more projects without depleting their bank account. 

Pros:

• Providers have deep knowledge of construction
• Relies on creditworthiness of the project, not the contractor
• No financial statements or credit check required
• Suppliers often provide cash discounts for upfront payment
• High spending limits
• No penalties for prepayment
• Quick turnaround time
• Low weekly or monthly payments

Cons:

• Financing fees apply

Home improvement financing

Home improvement financing is a type of construction loan that enables a contractor to as the intermediary between the lender and homeowner. While the homeowner must apply for the financing, the lender will typically pay the contractor up front for the job. The homeowner repays the loan to the financing company directly over time. 

Home improvement contractors may be able to use this type of financing to sell more jobs — or more expensive projects — especially to homeowners with limited funding. 

Pros: 

• Can help contractors sell projects to homeowners with limited funds 
• Often free for contractors

Cons: 

• Only available for home improvement projects
• Financing limits are low
• Relies on creditworthiness of the homeowner

Business credit cards

Credit cards are perhaps the simplest way to get funding for a construction company, but they are a poor solution to most cash flow problems. Without good financial management practices, using credit cards to fund expenses can cause contractors to dig themselves into a financial hole.

On most jobs, credit cards are not ideal for project-specific expenses, like buying building materials. Credit card bills must be paid off monthly to avoid interest charges, which is typically much shorter than the billing cycle on the project. 

Many cards have extremely high interest rates or annual fees, which can cost you lots of money down the road if you don’t pay the balance off each month.

Pros: 

• Almost instant approval
• Purchase rewards
• Easy to apply for

Cons: 

• High interest rates and fees
• Billing cycle doesn’t match timing of project payments
• You need a decent credit rating
• Can lead to cash flow problems down the road

Invoice factoring

Invoice factoring is a process in which contractors sell outstanding invoices to a factoring company in exchange for 70-90% of the amount up front. You receive the remaining amount, minus a fee, when your customer pays. The factoring company (also called a factor) takes possession of the receivables and your customer pays the factor instead of you.

While other financing options provide cash before costs are incurred, factoring is only an option after the invoice is submitted. This means that the contractor would still need to pay for the labor, materials, and equipment in advance. Factoring can help contractors avoid the long delay between invoicing and payment.

Pros: 

• Relies on your customer’s credit, not yours
• No ongoing payments
• The factor is in charge of collections

Cons: 

• Only an option after invoicing
• Your customers may feel uncomfortable paying a third party
• Lack of regulation attracts exploitative factoring companies

Equipment financing

Equipment financing operates like a car loan or mortgage: A bank gives you a loan to purchase it and uses the equipment as collateral. For construction companies, this type of financing may be used for heavy machinery, vehicles, tools, or pretty much any operational equipment that improves their workers’ productivity.

In general, the higher the financed amount, the higher the interest rate will be. Because equipment depreciates, banks don’t like to lend an amount equal to the full retail value of the equipment. However, there are some lenders out there that will finance 100% of the equipment value. More typically, the borrower will be required to put down a percentage of cash upfront.

Pros: 

• Usually lower interest rates (since loans are backed by collateral) 
• Added productivity from equipment can help pay for the cost of the loan

Cons: 

• Equipment loans may require a down payment
• Requires a credit check and financial statements
• Equipment can be repossessed if payments are missed

The risk & cost of contractor financing

Traditional lenders have long viewed the construction industry as too risky — and for good reason. Payments on a construction project depend on so many factors that are outside of a single contractor’s control, and it has been difficult for lenders to reliably determine a contractor's credit risk. 

Because the market has historically been underserved, a number of predatory companies have popped up to provide “loans” that aren’t governed by financial regulations, like factoring and merchant cash advances. Some of the companies offering these options use slick marketing and bold promises — but end up costing contractors way more than they initially think. 

How to qualify for better financing

Getting qualified for financing essentially involves convincing a financial provider that, if they give you cash, you will pay it back. The industry is making significant advances in the way financial providers calculate financial risk. 

Contractors should be increasingly careful about the projects they choose to work on. Lenders are now able to get a clearer picture of the financial health of a contractor (and a project) by looking at the payment practices of the other contractors on the job, the property owner, and construction-specific forms of payment security — like whether the contractor is protecting their mechanics lien rights.  

Traditional types of financing, like bank loans and trade credit, still rely heavily on a contractor’s credit history and financial statements to evaluate their creditworthiness. Contractors should work with their accountants or financial managers to consistently improve their tracking and reporting processes to ensure they can qualify for the right type of financing when they need it.

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