Five Tips to Secure Construction Financing with a Hard Money Loan
Many people believe it is difficult to get a construction loan. This assumption can be true in some cases. However, it is possible to get approved for a loan for construction with the right information and tools. It’s often a matter finding the right loan from a lender. Construction financing is now easier with the help of hard money lenders. They offer higher interest rates but are often not detrimental to the project. Also, they can be held for shorter periods of time so it is important to have an exit strategy before you consider a construction loan.
Due to the recent statistics on the rise in commercial and new home sales, construction loans are in high demand. The number of real estate sales has been increasing to the highest level in recent history. This has led to a decrease in inventory, making this a seller’s marketplace. How can you take advantage of this market by applying for construction loans?
These 5 tips will help you secure financing for your construction project.
- The loan amount and affordability. Before you proceed with the loan request or land purchase, it is important to know what your monthly financial commitment will be for a construction loan. The rate and the size of the loan will determine the cost of the loan. The rate will fluctuate depending on the borrower’s credit score, down payment amount, land ownership, and the builder’s experience and ability to absorb any potential cost overruns. This is common in construction projects.
- Evaluate different financing options. It is common to obtain a short-term construction loan for 12-24 months that gives you enough time to finish the construction and sell the property. These loans typically require monthly interest-only payments. This loan is great if you are building a house for sale. However, permanent financing will be required to repay the construction loan. The permanent loan closing will incur additional costs. A few lenders offer a “one-time close” which is a loan that begins as a construction loan but then becomes a regular mortgage within a certain time. This is a great option for those who are looking to build a home to keep as an investment or personal residence. Before they approve a loan for construction, many lenders require that the land be free and clear.
- Lenders may add interest-carry, or interest reserve to the loan amount in order to pay monthly interest payments over a certain period (or for the entire loan term). These funds would be credited to the loan balance as a construction draw and would be repaid monthly. This allows the borrower the freedom to focus on the project without worrying about the monthly payments. It also gives the lender more security as they know that they will receive their monthly payments.
- Budget and loan amounts should include contingency funds for cost overruns or contingency funds. Construction projects can often go over budget. To cover unexpected costs, lenders will often add 10-15% to the loan amount and budget to allow for overruns. These funds can be used to cover unexpected expenses, but the borrower will not have to pay any interest if they are not used. The lender may have set aside a contingency to cover the budget but the borrower should be ready to spend more than expected. Construction budgets are often overbudget and it can be very difficult to get funds to get construction underway.
- This is the most crucial part of hiring a contractor to supervise the construction. Seek out references from banks and clients who have worked with them to verify their capabilities.
Also, it is important to understand that construction loans are only available after work has been completed. This means that the borrower must have enough money to cover expenses until the bank reimburses them. Subcontractors should also be available that can wait until the bank pays. Many lenders reserve 10% of all advances until completion.