Construction financing is a very cost effective way to get into a property and/or to keep a property in the portfolio. Depending on where you are in the looking process, it can be extremely cost effective.
As we mentioned earlier, construction financing is most common for new construction, but it can be re-examined if the property needs upgrades or exterior work. Newer buildings can also consider lease-up periods, making it even more cost effective.
Some of the components of construction financing are: locating a building site, negotiating terms for a contract, and approaching lenders for funding.
Who is a lender?
A lender is a business that offers loans to people. Loan officers can approve or deny loans on the basis of creditworthiness and property value.
There are many different kinds of lenders, all with their own tricks and criteria for loan approval. Some use collateral; others do not. Some use standards for creditworthiness as the basis for approval, such as a mortgage debtors house or bank credit card accounts.
Some make no use of debtors house or bank credit cards in favor of applicants with limited credit but good judgment and properties. Still others use properties alone as proof of quality property ownership, which can be expensive to counter!
To help you find the best lender for your project, this article will introduce you to some key terms and explain how they affect the approval process.
What are the different types of construction loans?
Construction loans are a general term that mean either a construction loan or a land loan. Both have positive effects on your property, but the construction loan is more common.
The construction loan allows you to use your own money to remodel or construct your property. The land loan allows you to purchase property for a specific purpose such as constructing an apartment complex or a business district.
A construction loan can be resellable once the project is complete, which makes it a good investment tool. Resellability helps gain more interest on your project, which helps return more money to you!
Construction loans can be secured through banks, credit unions, or lending institutions. They can also be obtained directly from contractors or builders, depending on what type of project they are doing.
What is the loan amount?
When a property is purchased, a portion of the money from the sale of the property is used to fund the purchase. This funding can be through mortgage credit, debt consolidation, or equity in the new ownership.
When a loan is obtained for a property, it can be either a home equity loan, mortgage credit conversion loan, or non-occupational convertible debt.
A conversion loan may be useful for properties that are owned by multiple parties. If one party sells their property, the other parties must each contribute their fair share of the debt.
A non-occupational convertible debt may be useful for properties that do not have an original use. These types of properties may have new neighbors or owners next door that want to take over the property.
These types of debts may not be ideal for your property though. A residential (non commercial) property with heavy parking needs might not qualify for non-occupational convertibility.
What is the duration of the loan?
Most credit cards have rates set by the companies as standard. Some have lower standard rates, and some have higher, standard rates. Usually, the Standard Rate is greater than the Lowered Rate.
The interest rate is what you paid on it before the reduction. When you take a loan at an interest rate, that amount has to be paid off in a certain time frame, or it becomes a debt.
If you fail to pay off the loan in a reasonable time, the interest can accumulate and force a balance transfer or divorce, respectively! So, it is good to know what your average APR is before taking on any construction projects.
Many credit cards offer construction financing due to their lower average APR. Be aware of these before committing to a project though!ancaption.
What is the interest rate?
When a lender or investment firm offers construction financing, they typically offer several rates of interest. Some are variable, while others are fixed.
Some are arm’s length, while others are not. A private equity firm may offer a higher rate than a bank does due to their additional leverage.
As we mentioned earlier, when a mortgage lender offers a loan, they typically has a fixed interest rate and certain minimum monthly payments that must be met. When thebuilderoffers him or her a construction loan, the minimum loans can be lower due to the risk of owning and operating a building on your own!
Variable-rate loans may change at various times during the course of the project. A variable-rate loan may have certain up-front fees, but those will probably be removed over time by the lender. Variable-rate loans may change at different rates of progress, which can cause stress on both the borrower and lenders.
What are the required assets?
There are several types of construction financing available to commercial properties and buildings. Each has its own set of rules and restrictions, making them a little more complex to decipher.
Some of these structures include hotels, apartments, market-rate condos, and large office buildings. Of all of these, the office buildings are the most likely target for construction financing.
Of the three types of property that require construction financing, only the developers can request it. However, there are some restrictions that must be met in order for it to be granted.
Mostly, this includes having enough money to cover anticipated cost overruns and profit margins. However, it can also include having investors who will cover any financial losses if there is a shortage of funds.
What are the non-permitted uses?
There are a few things that aren’t allowed by law, but are very common. These include uses such as manufacturing that use roto-roes or constructions that use glue or nails to construct something.
Using loan proceeds for construction is also not allowed by law, so again, this is another way to finance your project. As mentioned before, construction financing is very affordable compared to other financing methods such as loans or equity investment from others.
There are two main sources for construction financing: banks and investors. Banks have criteria set out for projects they will accept and underwriters have standards they must meet for projects to get an underwriter designation.
Investors can be a bit tricky to find, but are usually more forthcoming with their money when developers meet their requirements. Many times these were cost savings created through construction.
What are the permitted uses?
Permitted uses for a project-based financing loan includes:
1. Development of a commercial or industrial use;
2. Construction of an addition, addition and alteration to an existing building; or
3. Construction of an annex to an existing building. (All three require re-approval by the city.)
The permitted uses are determined by the type of development being approved for construction, the projected use of the development, and how much development can be monetized in one project. The permitted uses do not factor into the price that a developer can offer their deal at as they do not take into account what sites are available for development.
A lot of times developers will apply construction financing as if they had all four permitted uses, which is not legal! Only apptinent for reviewed after projects have been built.