Construction Financing: Five Tips for Getting a Construction Loan

Here are five tips that will be helpful to broaden your knowledge of construction project finance:

 

1. You need to know if the requested loan is within your budget and what the monthly payment is going to be before you run out and buy land. Things to consider are the following: what is your FICO score ( high or low), do you own land free and clear , do you have experience, what exactly do you want to accomplish and how, how much money do you have for a down payment. Construction loans are often ‘story loans’ so make sure that your “story” is a well-told narrative of the situation;

 

2. It is good to be aware of your options for financing. You can get a short term 12 to 18-month construction loan that you will have to refinance into a new conventional mortgage loan once construction is completed. This approach has its pros and cons. On the one hand, you will face two sets of closing costs going through the loan process twice. But on the other hand, once the project is completed, you will have more flexibility when shopping around for conventional mortgages. A popular construction loan is the ‘one time close’ or construction to permanent loan. You will have one set of fees and one closing;

 

3. Interest reserve is an estimated interest payment over construction period, which is added to your loan amount. This is a tool created to benefit the client, so it will not be necessary to make a monthly payment during construction period. However, because the reserve is added on top of the loan amount, you will pay interest on the total amount. You will need to make this decision:  whether you want the interest reserve to be added or you just want to pay monthly interest payments out of your other business proceeds.

 

4. Contingency funds are added to the loan amount just because construction projects tend to have cost overruns. Banks normally add 5-10% of cost breakdown to the loan amount. Again, it is your choice to agree on that or not;

 

5. It is crucial to know about possible options for interest rates. Interest rate can be locked until completion of construction or can be floating. Many lenders have higher interest rates if you lock upfront.  Some lenders would not allow you to lock the interest rate until the construction period is over. The other thing to consider is if the rate stays the same after construction is finished and the loan is converted into a mortgage. You need to make sure that choosing the floating interest rate will not cause you a problem with monthly payments once rates will go up.

 

Finally, how do you find the right lender for your construction loan? One way to look for construction financing is to go to every bank in town. Most of the time, you will not get anywhere. If you do find a bank that will do a construction loan, they usually can offer one product that may or may not be right for you. Magna Capital Group provides different options to clients with construction loans for residential and commercial construction projects.