Pete Mugleston | Mortgage AdvisorPete has been a mortgage advisor for over 10 years, and is regularly cited in both trade and national press.
Updated: 4th July 2019* | Published: 3rd July 2019
We hear from hundreds of customers who are looking for construction finance loans to fund developments of various kinds, from large-scale commercial schemes to residential projects. Many of them are ready to apply for development finance and need someone to guide them through the process, while others want to know about the other options that are available.
We’ve put together this comprehensive guide to finance for construction, and you’ll find the following topics covered below…
Read on to find out more about the finance options that are available for construction company professionals and developers, or better yet, make an enquiry and the expert brokers we work with will talk you through them and connect you to the right lender.
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Construction finance is a term that’s occasionally used to refer to development finance, a type of short-term loan for funding construction projects. These loans provide capital for the initial site purchase (usually at 70-75% LTV) and the subsequent building work too.
Development finance loans are similar to bridging loans, in the sense that they’re usually offered on an interest-only basis at higher rates than mortgages, and require the borrower to evidence an exit strategy in advance, i.e. a means of paying the debt at the end of term - this would usually be through a remortgage or the sale of the scheme post-completion.
The term is usually very short, with 12 months or less quite common.
The key difference between development finance and bridging is that the capital to cover the construction work is distributed in staged drawdowns. The advantage of this is that interest is only payable on funds that have been drawn down. The lender will usually request a site inspection to ensure the project is on track before approving the next stage of funding.
In addition to development loans, there are also alternative sources of finance for construction projects available, which we will cover later in this article.
How to finance the construction of a new home
How do you fund the construction of a new house? This is a question we hear all the time.
There are a small number of lenders who will offer development finance loans to borrowers with the means and expertise to build a residential property. In this scenario, the exit strategy would be either the sale of the home or a remortgage onto a residential deal.
A development finance loan would give you the capital to initially buy the land and bankroll the construction itself through staged payments that you can draw down.
Development finance can be tricky to obtain for residential projects as most of these loans are offered on an unregulated basis. The minority of lenders who do provide them usually include caveats such as a maximum loan term of just 12 months.
It may be possible to find a favourable deal with the help of a specialist broker, but in many cases, a self-build mortgage is more viable to finance the construction of a new house.
A self-build mortgage works similarly to a development finance loan. The payments come in stages and it’s common practise for the lender to order site inspections to ensure everything is going to plan. The latter payments are made when the property’s roof is secure and the interior walls are plastered, and the final instalment comes on completion.
Self-build mortgages usually come with significantly higher rates than standard residential mortgages, due to the increased risk the lender is taking on.
Deposit requirements are also higher, as you will need to put down at least 25% to get one of these loans. Furthermore, some lenders might ask for as much as 50% if you have bad credit or limited construction experience.
If you’re unsure what type of construction loan you need to finance your housing project, get in touch and the expert brokers we work with will discuss all of the available options. They can also introduce you to the right lender if you choose to press ahead.
Commercial construction finance
Development finance is often a viable option for commercial developments, including…
Professional properties (e.g. doctor’s surgeries, private schools etc)
As is the case with bridging loans and commercial mortgages, development finance applications are usually assessed on a case-by-case basis. Whether yours is successful (and the rates you end up) with will largely come down to the strength of the exit strategy and the viability of the investment, which the lender will determine by looking at factors such as how much industry experience you have, your credit rating and your deposit/security.
Most development finance lenders would be willing to offer capital to cover 70-75% of the initial site purchase and 100% of the construction costs (the latter in staged drawdowns).
The exit strategy for commercial development finance would usually be refinancing the debt via a business remortgage or selling the scheme post-completion.
Due diligence will be done on the appetite for the business in the area the property is being built. For example, a lender would be more willing to lend on a hotel project that's being built near tourist attractions and good transport links than to one in the middle of nowhere.
Hotel construction finance
Development finance loans for hotel developments are assessed in the same way as loans for other commercial construction projects. There are lenders who specialise in this sector, but applications are usually judged on a case-by-case basis, based on the strength of the exit and the viability of the investment.
In addition, most lenders will be keen to see that you have the necessary licencing to operate in this sector, if you’re plans involve running the hotel yourself afterwards.
Not all development finance providers specialise in hotels and the ones which do might carry out more stringent checks and request extra deposit/security if there are any factors driving up the level of risk, such as bad credit or the borrower lacking experience.
How much interest will I be charged during my construction finance project?
Interest rates for development finance are typically higher than mortgages, but the exact rate you end up on will be determined on a bespoke basis, and may depend on factors such as the level of risk, the strength of the exit strategy and your industry experience.
Most development finance loans are offered on an interest only basis over a short period, usually between three months and three years.
You will only be charged interest on the capital you have drawn down, and not the capital that is due to be released at a future stage. However, most lenders will charge for every site inspection they have carried out, adding to the overall cost.
What other suitable sources of finance for construction projects are there?
Development finance is not the only option if you need to raise funds for a construction project.
Possible alternatives include…
Equity finance in construction
Equity finance is when a business gives up a share of its ownership to an investor(s) in exchange for capital. If you’re a business owner, this could be a means to free up funds for a construction project, but relinquishing equity should never be done lightly, so be sure to seek specialist advice first.
Bridging loans for property development
Bridging loans can also provide short term finance for construction purposes. If you already have capital set aside for the building work, a bridging loan could be used to purchase the site itself and a sale or remortgage based on its post-development value could provide the exit strategy.
Self-finance solutions for construction
Self-financing simply refers to generating the capital from your own income, instead of using external sources such as lenders or investors. Some trading businesses find themselves in a position to invest in property development with funds they have built up themselves.
Using equity in other securities
Releasing any equity you hold in other properties or assets could provide another alternative construction finance solution. If you or your business has any commercial mortgages or asset finance agreements in place, refinancing these loans could free up equity to invest in a construction scheme.
Other types of debt finance for construction
Depending on how much you need to borrow, other forms of debt finance could provide supplemental funds to bankroll a construction project. For example, if £25,000 or less is needed because you already have some capital to invest, an unsecured business loan might be an option.
These are just a few of the alternative finance options available for developers and other professionals in the construction industry. If you’re unsure which product is right for you, and to discuss other possible alternatives, make an enquiry and the advisors we work with will discuss all of your options and connect you with the right lender.
Speak to a development and construction finance expert
If you have questions and want to speak to an expert for the right advice, call Online Mortgage Advisor today on 0800 304 7880 or make an enquiry.
Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances. We don’t charge a fee and there’s absolutely no obligation or marks on your credit rating.
*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA.Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.
Pete, an expert in all things mortgages, cut his teeth right in the middle of the credit crunch. With plenty of people needing help and few mortgage providers lending, Pete found great success in going the extra mile to find mortgages for people whom many others considered lost causes.
The experience he gained, coupled with his love of helping people reach their goals, led him to establish Online Mortgage Advisor, with one clear vision – to help as many customers as possible get the right advice, regardless of need or background.
Pete's presence in the industry as the 'go-to' for specialist finance continues to grow, and he is regularly cited in and writes for both local and national press, as well as trade publications, with a regular column in Mortgage Introducer and being the exclusive mortgage expert for LOVEMoney. Pete also writes for OMA of course!
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