Getting the money together to fund your self-build, extension or commercial construction project can be a challenge. So it’s worth looking into all your available options and considering costs prior to making any decisions. In this article, we’ll look at how different types of loans work – and crucially, how to secure a building or construction loan.
What is a building loan?
Building loans are short term loans you can utilise to fund the construction costs of a building project. Many different types of builds are covered and building loans can be called various terms, including homeowner loans, house-building loans, construction loans and home building loans.
They differ from traditional mortgages, which are based on similar sales and the property’s value. When it comes to a building loan, the loaned amount depends on the total cost of the build. Mortgages are given as a one-off lump sum, but a building loan is typically paid in ‘draws’, or pre-agreed instalments. They are usually shorter than your typical home loans and can involve higher interest rates. It’s not unusual to have a year-long contract to allow for the property to be built.
Building loans – fast facts
- They cover the cost of a building project.
- The finished property value doesn’t determine how much you are loaned.
- Another short-term option to fund property is Auction Finance.
- Paid out in instalments rather than all upfront like a standard mortgage.
- Instalments – or draws – are pre-determined by the building process stages.
What is construction finance?
Construction finance refers to funds used to bridge the gap between the completed work and payments for the work. Building loans come under the general umbrella.
In the case of construction companies, flexibility around financing is essential. There’s a lot of demand across the UK and it’s hard for housebuilders to keep up with it. Due to this shortfall, a target has been set to build 300,000 new homes by mid-2020 – meaning the pressure is on.
Lots can happen to hold up house building, such as late payments, the extension of payment contracts, and other projects – all of which can make it hard for companies to pay wages and meet their goals. Construction finance aims to help with these challenges.
How does it work?
Firms are able to purchase their materials, pay their workers, and hire the equipment they need with the cash flow coming from construction finance. These types of loans also allow businesses to utilise the funds for outstanding invoices. This is known as construction factoring. Sometimes it can be used for payment applications and work that has been partially completed.
In short, a construction loan is a prepayment provided by the lender. As with all other loans, factors such as your credit history and score along with any other debts are considered prior to you being approved.
Construction finance – fast facts
- Used to ensure that the gap between work being done and the payment for that work is as unnoticeable as possible.
- Short-term as a general rule.
- For construction firms with targets, it’s a crucial element for flexible funding.
- Allows funds to be raised for payment and outstanding invoices against new applications.
- Helps companies to keep building and doing what they do to keep the ball rolling.
- When cash flow is tricky or uneven, it’s great for making sure contractors are paid.
How much do building loans cost?
This varies depending on the finances of the company or individual, and things such as your existing debt and credit history. The amount you seek will also determine the interest rate and the payment schedule. Construction and building loans are meant to cover the cost of the build, so how much you borrow really depends on the size of the project. You’ll be asked for a lot of information about your intentions with the project, so make sure you are honest and realistic.
Where other circumstances prevent building, construction loans make it possible, but you need to ensure interest rates are considered. If you’d like to draw on your construction loan, you’ll likely be paying a variable rate, which can go up or down. A lot of construction loans are interest-only, meaning you’ll be paying interest on the total borrowed amount as opposed to the loan balance.
When it comes to new construction, you’ll probably need to put down a large down payment. There’s more risk with a construction loan than a home loan, so interest rates will usually be higher. The type of loan will determine the cost as well – a building loan works differently to a small business loan even if they are both for construction. The deposit you need to put down is usually around 20% and 25%.
How long until I get the money?
This varies. If you are organised, meticulous and realistic, the process can be incredibly quick, and sometimes even completed online. Depending on circumstances and the nature of your project, you can have access to the funding within a few weeks.
Can I use a building loan for home renovation?
Yes, but make sure you do your research as there are other options out there. It pays to shop around, so make sure you’re getting the best deal!
What are the disadvantages?
- The property may not be completed within budget and/or on time. If the work takes longer than anticipated, you might need to pay a fee to extend the loan.
- The construction costs might exceed the value of the finished building. This could be because the market fails or that the builder is not up to scratch. If this happens, you would need to find extra capital to refinance the construction loan into an end loan.
- Non-eligibility. If your income or credit changes during the time of the project, you might have your end loan application declined. Construction loans are not supposed to be permanent so this could create a problem. If you can’t pay the balance by refinancing and the lender refuses a loan extension, they could assume ownership of the building.
Banks can be cautious when it comes to lending, so make sure your plans are stringent before setting out an application.