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What is Construction Finance?

What is Construction Finance?

Many people in the UK prefer building their own houses instead of purchasing existing homes. Before you start the construction project, it is important to establish how much money you need. After that, you will need to apply for a loan for the project, and this loan is referred to as construction finance.

You should note that loans for construction or home renovation are different from mortgages. Unlike construction loans, mortgages are given for the purchase of homes, and they typically have a repayment period of more than 30 years. Construction loans are usually paid back within a year or less. Also, you should note that construction loans are not given as a lump sum and are instead disbursed as you make progress on the building.

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The benefits of Construction Finance?

Construction finance will give you the necessary capital to complete your project. You can use the funds to hire staff, purchase materials, and purchase equipment. Although construction loans have short repayment periods, financial institutions will usually allow you to convert the loan to a mortgage when the building is completed. With this option, all your financing will be rolled into a single transaction, meaning you will only need to make one application and go through one closing.

How does Construction Finance work?

When you apply for construction finance, the bank or institution will check your credit score and debt-to-income ratio. They will then gauge your capacity to repay the loan. Once the loan is released, you will have to make a down payment. The down payment for construction loans is usually quite high and will be calculated based on the amount of credit you need. As noted earlier, construction finance loans are not released as lump sums and are instead given in a pre-determined sequence.

The outstanding loan will usually be matched closely to the value of the project as this will help to reduce the lender’s risk. In many cases, the developer will only be required to make interest-only payments to the bank as the construction progresses. To lower the interest, you should aim at completing the project as quickly as possible. Payment of the construction loan is typically made when you sell the property. Another common option is to convert the loan to a permanent mortgage, which you can then pay using rental income from the property.

Before the bank or lender gives you the loan, they will evaluate several factors, including:

• The experience you have as a developer
• The net worth of the developer
• The viability of the project

They will also need to see the operating pro forma for the project, and this should indicate the anticipated income and expenses for the construction period. You should also hire an experienced and professional team for the project, as this will inspire confidence in the lender.

Construction finance can be granted for personal home construction or commercial property development.

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The cost of Construction Finance

The cost of construction finance is simply the amount of money you will need to pay on top of the actual loan amount. Here are the charges you will incur:

Service charges – These are the fees you will have to pay for the administration of the loan, and they are calculated as a small percentage of the total loan. Usually, the service charge is about 0.5% of the loan
Discount charges – This is the interest rate on top of the lending rate of the Bank of England. It usually amounts to a minimum of 2.5%, and, when added to the Bank of England lending rate, you will get a total fee of 3%
Annual fee – This is a small fee charged for using the facility
Valuation fees – This is charged for the report on the development. There is no fixed cost for the valuation, but it will usually be higher for more expensive projects
Broker fees – You may also need to pay a broker to compare rates from different lenders

The interest rate of the construction loan will vary depending on certain factors, and these include:

• The size of the loan
• The credit history of the applicants
• The experience of the developer and the team
• The location of the project

You should note that the interest rates are decided on a case-by-case basis, so the only way to get a good deal is to shop from multiple lenders. Since this can be a little challenging, you should consider hiring a broker. Also, remember that the interest and fees charged can be offset against taxes, and this will lower your liability.

When applying for the loan, you should also discuss the repayment plan. In most cases, you will not be required to make monthly payments on the loan and should only pay the interest.

Who is eligible for Construction Finance?

In order to qualify for construction finance, you will need to have a minimum credit score of 500. To qualify for lower down payments, you will need to have a credit score of more than 580. This requirement varies among lenders, and some will even require applicants to have credit scores of 720 or higher. Generally, lenders will give you better interest rates if you have a higher credit score.

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When building a house, cash flow can often be a concern, and this is where construction finance will come in. These loans are typically meant to be paid back within a year but, as mentioned, you will always have the option of converting them into mortgages later on. This way, you will be able to pay the loans over many years. If you are constructing rental properties or commercial spaces, you will be able to use the rents to cover the repayment of the mortgage. Construction loans come with various costs, including service charges, discount charges, and valuation fees. You will also need to pay a broker to compare rates from different banks. The lender will choose the interest rates based on several factors. Some of these are your credit score, your experience as a developer, and the size of the loan.

Why choose Buildsafe?

As specialist independent advisors, we provide clients with tailored policies for each development, helping them to make well-informed decisions. Our experts have over 40 years’ experience in the property sector, so you can be assured that your Building Warranty and Construction Insurance will be handled with great care. Our team will manage the process for you, ensuring you receive the best price from the market, and saving you time and money.

To speak with a specialist broker call us on 0203 701 0422 or fill out our online enquiry form.

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