Whether you’re a family looking for their dream home or a developer making a new business venture, construction loans can help.
These loans are beneficial to those looking to finance a newly-built project, whether that be a house or for a business.
Just as with traditional mortgages, there are many ways borrowers can secure construction loans.
But their differences from a conventional mortgage, and the pros and cons of different lenders, can feel like a lot to understand.
We’re providing a complete construction loans guide to help you understand what the loan is, how it can help, and where to get one.
What’s your loan scenario?
What is a construction loan?
New construction loans are a form of short-term financing for the purpose of building a new house, business, or other real estate projects.
A construction loan can help you build your dream home or expand your company. It’s particularly helpful if you still need to purchase land as well.
Construction loans cover the costs of building the house, as well as construction equipment, building materials, permits, and labor. You’ll need to qualify for this loan just as you would with any other.
They differ from conventional mortgage loans though because the property you’re financing doesn’t exist yet. Since there is not yet a property to serve as collateral, banks consider these loans a high risk. Qualifications for this loan are stricter than a conventional loan to accommodate for the amount of the lender’s risk.
A detailed application process takes place. The borrower submits information such as total funding required, information about the builder, a projected timeline, floor plans, and a breakdown of labor and material costs.
The borrower can use the equity from the already purchased property as a down payment for the construction loan.
That’s why many borrowers looking for construction loans turn to private money lenders instead of traditional ones. Their relaxed requirements and quick timelines allow for borrowers with unique financial situations to get approved. They also don’t require the same amount of inspections on the project as a traditional lender does.
If you’re an investor considering an equity or joint venture partner rather than other types of financing, keep in mind that these partners often want a 50/50 split partnership. Even for those only wanting 25% of the profits, for example, this ends up being much more expensive than the costs of a hard money loan.
How do construction loans work?
Traditional construction loans are paid out directly to the builder in installments as each stage of work is completed.
The borrower will make monthly payments on the loan. Through a traditional lender, interest payments might only be required while the construction is still happening.
Many inspections and check-ins are required throughout the project with a traditional lender.
Construction loans are similar to a line of credit where interest is calculated on the actual amount you end up borrowing to complete each portion of a project. A hard money lender will set the interest term based on the loan you take out with them.
Some construction loans through traditional lenders may require the loan balance to be completely paid off by the time the project is complete.
The thought with a construction loan is that once the property is built, borrowers will then seek a traditional mortgage. If the borrower was living in another house while this one was completed, they can now sell it and use that toward paying down the construction loan.
Construction-to-permanent loans are also available. The loan converts to a regular mortgage loan when the building is done.
Requirements for a construction loan
Traditional lenders will need to evaluate your financial situation including your credit score, Debt-to-Income (DTI) ratio, and how much you can provide for a down payment.
Additionally, you’ll go through a detailed application process including providing the following information:
- Total funding required
- Information about the builder
- A projected timeline
- Floor plans
- Breakdown of labor and material costs
Traditional requirements for this loan also include the following qualifications:
- Loan must be used for the construction of a new property
- Large down payments, typically 20-25% of your total project cost
- Good to excellent credit score
- DTI below 40%
This is where a borrower could use the benefits of a private money lender, which include:
- Low credit scores allowed
- Higher DTI accepted
- Closing in days rather than months
- Loans based on After-Repair Value (ARV) and future value of the asset
Private money lenders focus on the equity and asset value of the property you want to build. If your situation makes sense, they will provide the funding quickly and efficiently.
Sometimes the borrower needs the home to be built quickly so they can sell their current home and get their family into the new one. Or perhaps, they have already sold their previous home and are staying somewhere temporarily. Approval and closing over months with a traditional lender just isn’t feasible in this situation. The extra time it would take for inspections and other regulations would continue the delays.
A hard money loan’s quick turnaround time is the better solution there. You’ll have more control over the process. You won’t need to depend on strict timelines and budget that need to be frequently re-evaluated by a traditional lender.
If you’re an investor or developer, a hard money lender will take into account your specific project and make a common-sense decision based on the scenario you provide. Building a relationship with a hard money lender can make it much easier to fund future build projects.
How to get a construction loan?
If you are confident in your ability to get qualified and are not under a time crunch, most banks, credit unions, and other traditional lending institutions offer construction loans.
But if you’ve read our construction loans guide and are now reconsidering, reach out to Marquee Funding Group.
Our team of real estate experts will review your unique situation. Marquee specializes in complex or unusual circumstances that still make sense financially but don’t qualify for traditional financing.
Getting a construction loan when you have a more complicated financial situation might present challenges to traditional institutions due to various requirements, but these transactions are typical deals for our team.
We want to build a long-term partnership with investors, so that future projects can be financed with ease.
Submit your loan scenario today to get started.