When looking to build a new home, extend your current property, or develop a high-rise project, it can be an exciting time. However, good decisions need to be made and this is especially true when it comes to money. Ultimately, financing is one of the biggest decisions you will make because, if done incorrectly, you could be left in debt for many years to come. With this in mind, we should introduce ‘construction financing’.
Otherwise known as construction loans, self-build loans, and many other names similar, construction financing is a short-term arrangement made to finance any real estate-related projects. To get started, the home or land owner will take out the loan to cover all the related costs of the project and this helps to get started before a more permanent source of funding becomes available. For the lending company, the loans have more risk than regular loans so the interest rates are generally much higher.
At this point, it is important to note that the loan is essentially taken out for the builders so they have the money to complete the project. As soon as the work is completed, the permanent loan – also called the ‘end loan’ – can be used to pay off this short-term deal and you can carry on as usual. In addition to this, the construction loan can be refinanced into the permanent mortgage and this is the route that many people choose.
At the very least, a 20% down payment is normally required from most lenders on the loan. To be approved and the finance made available, you will also have to prove the work you plan to do as well as proving that you have already contacted a qualified and trusted builder. In the application, you will also need a ‘blue book’ which shows all the construction details for the project but we will go over all of this in more detail a little later!
As we have seen, all of the related costs will be covered by this loan but what exactly does this mean? Over time, you are likely to see a number different costs so you should be aware of what is covered and what isn’t. Below, we have a breakdown of these expenses and how they work!
At the start of the project, you might want to cover the purchase of the land and this can be done with construction financing. Of course, this might not be necessary depending on whether you already own the land or not so this is normally dealt with on a case-by-case basis. If you already have the land and are looking to take the next step into construction or if you are extending your home, keep reading.
Firstly, the loan will cover any costs that are directly related to the building work being done so this means labor as well as the raw materials. Without either of these two factors, the construction cannot start so these are both essential to your project.
After this, you have costs that are indirectly related to the project which means that they arise as a result of something else. For example, this could include engineering fees, permit fees, and architectural fees. If the cost doesn’t directly relate to contract but it does enhance the project somewhat, it falls into this category.
Although we try to plan property costs as closely as possible, there is always the chance of seeing some unforeseen expenses along the way so this contingency fund is perfect. Generally, you will find that an extra 10% will be added on top of the construction costs as a contingency account. At times, orders will need to be changed or upgrades are required so this contingency amount is highly recommended. If you find that it doesn’t get used by the end of the project, at least you had it there for security and peace of mind.
After the actual construction, you will probably need items in the home or extra room such as flooring and other products to make it ‘livable’. For these costs, they are covered well in this section.
Taking all of the previous categories we have discussed in mind, you will come up with a total cost for the entire project. When the company is deciding how much you can borrow, they will take the lesser of the total costs or the appraised value.
Finally, lot equity may also be found and this is the difference in value between the loan to be paid off for the land and the appraised land value itself. If there is any at all (sometimes there isn’t), it will be credited towards the down payment.
Now you have seen what costs are covered and understand how the process works a little more, you need to know how to apply. Here, we have provided a brief step-by-step guide so you can get the general idea. Ultimately, your experience may differ slightly depending on the project you have in mind but this is a general guide.
At the very start, you will need to obtain the architectural drawings for your project. In addition to a floor plan, it must have the exterior, dimensions, descriptions of the materials, and more. For example, the roofing may consist of lightweight tiles, shingles, or many other materials so this must be clarified. Once this has been given to the appraiser, they can decide a value subject to the specifications.
Here, an agreement will be made with a contractor for the complete project. Using the plans from ‘step 1’, the builder should provide you with a quote as well as timings. After you have obtained this, it should be kept together with the initial plans and specifications for the project.
From here, the builder should go off and create a detailed contract with all the costs broken down into sections. Often called the ‘draw schedule’, this should match up with the quote in the last step and this helps the money to reach the owner or the builder before the project begins.
Next, a single case worksheet is used as an assessment of all the costs. Eventually, this document – it may have a different name with different companies – will help decide the maximum loan amount. Normally, the lending company will take control of this step so you don’t have to worry about anything except for providing accurate information at the beginning.
Finally, the builder will provide their own information but this isn’t something you need to do or chase up. If you choose a trusted and reliable contractor, there won’t be any problems at this stage.
To finish, we have some extra information that might prove interesting for you. For example, a typical construction loan will last for around 12 months. During this time, only the interest payments will be necessary as your home or extension takes place. If you are building a new home whilst living in another, you don’t necessarily have to sell first because of this 12-month period. Rather than moving twice, the loan allows you to stay in your existing home while the building company work on your future home. Then, you can move in upon completion and sell in the same window.
As you can see, this can be an incredible tool when building a new home or completing some renovation work on your existing property. Rather than having to find the funding or struggle with some financial difficulties, you can simply borrow this short-term option. Then, as soon as you are ready, you can pay it off with a more permanent source such as a mortgage. Essentially, the mortgage will repay the loan and you can continue with the mortgage as you would normally.
As you can imagine, there are several variables within this process such as the builder you choose, the value of the property, the value of the work being done, and more. However, we can help you with whatever you may need. We realize that building your home is an exciting time so we offer a flexible service at an affordable price. Once you contact us, we will work towards a tailor-made financial solution to help make your dream come true!
Get Construction Financing when you:
- Take on a single home construction project
- Develop sub-divisional or high-rise projects
- Finance commercial development
- Fund conversion projects
Study 1: Luxury Home Construction
Asset Value: $1,850,000
- Purchase of renovators dream + Construction of property in a high demand area surrounded by Multi-million dollar homes mixed between old tear-down ready properties
- Client with bad credit and poor repayment history
- 0% Down
- Purchase with Private Mortgage and Vendor Take back portion
- Competitive Private Mortgage rate
- Client was able to build property with no money invested
- Property sold at a profit
STUDY 2: Mixed Commercial/Residential Building
Asset Value upon completion: $22,000,000
- Builder had poor credit
- Bank would not want to provide money for construction
- Current mortgage was coming due
- Found 3 Million Mezzanine financing which guaranteed 1st mortgage from the bank
- Bank provided 1st and Construction Mortgage
- Building completed at profit