A construction loan is a small loan aimed at funding investment projects like homes, condominiums, and other real estate projects. These are not like a mortgage, although they can be converted into permanent mortgages as they are used for construction projects.
Construction loans are suitable for all kinds of construction projects. The length of these loans is up to one year. After the end of the term and when the building construction is completed, you can refinance the loan into a permanent mortgage, or you can take out a new loan to pay off your construction loan once and for all.
As far as it is about payments, it depends on the policy of the lender. Some will allow you to pay only interest during the construction underway, while others may require you to clear all the dues at the end of the term. Usually, the money is dispersed in the construction phases. Therefore, the interest is calculated only on the released amount. This is how you can save a lot of money in interest.
If you choose to pay off the entire balance at the end of the term, it can cost you an arm and a leg.
How to take out a construction loan smoothly
Taking out a construction loan is not that easy. It could be more challenging than getting a mortgage. When it comes to construction finance, most lenders consider it risky. Therefore, there are always strings attached.
Here are the requirements you will have to fulfil when you need to take out a construction loan:
- Down payment
To get a construction loan, you will need a down payment of up to 20% of the total cost of your construction project. Some lenders may expect you to put down more depending on your credibility. It means you cannot just get to a lender straightaway and expect them to fund your construction project.
At the outset, you must have some funds with you to get it off the ground. However, if you already own a piece of land, you can put it down as an upfront payment. Construction projects are risky because sometimes things do not go as planned, and borrowers make a getaway with financial commitments.
They expect a higher down payment to ensure that you will continue to make payments despite the fact that the project goes awry. Talk to them before you apply for the loan.
- Strong credit score
Your credit history is paramount to getting the nod from a lender. Although you need a small amount of money, you must have a good credit score. The higher the score, the lower the interest rate will be. Apart from your personal credit history, a lender will thoroughly check your business credit rating too.
Do proper research beforehand. Development finance lenders have different criteria. Try to compare the size of the down payment, payment methods, and the term of the loan so you pick an option that suits you fine.
- Financial documents
You will be asked to provide financial documents, which include but not limited to income statement, tax return, and proof of other assets. A prospective lender will carefully analyse your financial documents to determine whether you can repay the debt even if your construction project fails.
Arrange all these documents in advance so you do not face a delay in the processing of the loan. If you are looking to get funding with the help of a broker, they will let you know about all documents, and then the rest task they will do.
A lender will check the reputation of a builder as well to track their record in the construction business. Previous work history, online reviews and subcontractors’ remarks will play an important role. Before you finalise a deal with a builder, make sure that they are known for the quality of their work, as a lender or finance company would also like to know about it.
Ways to choose the best construction finance company
Here are the ways you can choose the best construction finance company:
- Shop around the best construction financing company
Some financing companies may offer you wider options, while others may offer you a limited option. If you still cannot arrive at a conclusion, you should choose a professional broker. As they have some construction finance companies in their plan, they can find you the one that matches your requirements.
- Assess the experience
There are also some lenders that provide construction loans apart from construction financing companies. Make sure that you choose a lender that has experience in providing construction finance. You can also ask a lender to provide the details of their previous projects so that you can get an idea of their work.
- Tap into your network
Before you choose a company for construction finance, you should tap into your network. Ask people if they know a reputed lender or finance company that provides construction loans at the lowest possible interest rates.
Your personal network is the best way to find a good place to find the best lender or finance company. If you have a good relationship with a bank, lender or finance company, try to approach them. You will definitely be able to take advantage of a good relationship with them to get an affordable construction loan.
To wrap up
Applying for a construction loan is certainly challenging. Though these loans are short-term loans, the lending amount may be a bit large. Have your credit score up to scratch. Remember that your business credit score is also important.
In addition, you should have larger money for the down payment. The higher the deposit, the lower the loan-to-value, and the lower the interest rate will be. Tap into your local networks to choose a financing company. Make sure that the lender or finance company you have picked for your project has considerable experience in providing a construction loan.
Before you opt for a construction loan, ensure that you have a backup plan. Your construction project will likely fail. You cannot escape debt payments. You must have a backup plan.
Harry Kane is a financial writer and author who has covered wide topics related to business loans and finance for the last decade. He has been working as the Chief Contributor in finding out deals on various business finance products covered by Thebusinessfunds, a reputed business loan broker firm in the UK. The primary work of Harry is to analyse the loan requirements of various businesses according to their circumstances and affordability. He directly communicates with the loan aspirants and guides them to get the right loan matching their needs. He has a vast experience in finance writing, working with many major business firms in the UK. At Thebusinessfunds, Harry also used to write well-researched blogs covering the financial problems of business loan aspirants and providing relevant solutions. He is a postgraduate with MSc. in Banking and Finance.