What Is a Construction Loan Note?

A construction loan note (CLN) is a debt obligation used for the funding of construction projects such as housing developments. In most cases, the note issuers repay the note obligation by issuing a longer-term bond. The proceeds from the bond pay back the debts on the note.

Understanding a Construction Loan Note

A loan note is a legally binding agreement that can be drawn up by either of the contracted parties and is valid until the loan is paid in full. The note enables a payee to receive payments over a set period. Payments frequently include interest and end with the satisfaction of the loan.

A construction loan note is a specific type of loan note, which appears commonly at the municipal level. A large city might use a construction loan note to finance a civic or housing project. If a city experiences a boom in population, for example, it may need to build additional housing quickly. The project can get underway when the municipality issues a construction loan note to the builders. Cash flow from the note allows for construction to start rapidly. The city will then issue a long-term municipal bond to repay the construction loan note.

A large city may finance a housing development with a construction loan note, which provides money to builders to get the project underway.

A municipal bond is a debt security issued by a state or municipality. Cities use municipal bonds to finance public projects and capital expenditures. These public projects can range from city housing in the above example to the construction of highways, bridges, or schools. Municipal bonds are exempt from federal taxes and most state and local taxes.

Construction Loan Note vs. Promissory Note

Extended from one party to another, the construction loan note is itself a type of promissory note. As a financial instrument, a promissory note contains all the terms of the debt. It has a written promise by one party, such as the note's issuer or maker, to pay another party, such as the note's payee, a definite sum of money. Like the promissory, the CLN will list the principal amount, interest rate, maturity date, date and place of issuance, and issuer's signature.

Promissory notes occur most commonly with funding sources outside banking institutions, such as an individual or company. It falls between an IOU and a loan contract regarding its rigidity. A promissory note includes a specific promise to pay, and the steps required to do so. A loan contract, on the other hand, states the lender’s right to recourse if the borrower defaults.