Constructing a new building or remodeling an existing one is an expensive endeavor that can easily break the bank. However, with proper planning and understanding of construction finance, you can make your vision a reality without going bankrupt. In this article, we’ll provide you with a brief overview of construction finance and important things you need to know before starting your project.
Construction finance refers to the process of funding the construction of a new building or renovating an existing one. This process involves obtaining loans from banks or other lending institutions and managing the funds during the construction process. It’s important to distinguish construction finance from traditional mortgage loans, as construction financing only covers the period of construction. Once the project is completed, the loan converts into a long-term mortgage loan.
To build or renovate, you’ll need capital or funds to pay for construction costs. Construction finance is not a one-time payment; rather, the funds are disbursed in stages, as the building or renovation progresses. This is also known as a draw schedule, and the contractor uses it to keep tabs on the project and ensure that the work is progressing as planned.
Lenders typically loan up to 80% of the total project cost, but you’ll need to provide a down payment, also known as “skin in the game.” This can range from 10 to 20% of the total project cost and is a safeguard for the lender, as it ensures that you have a vested interest in the project’s success.
During the construction process, the lender disburses funds, or draws, as each construction phase is completed. A payment request is given to the lender by the contractor, who then evaluates and inspects the work done to determine if it is up to standard and approves the request. Once the lender approves the request, the funds are released, and the next phase can begin.
As part of the construction finance process, you’ll need to consider interest rates. Interest can accrue on the money you borrow, and depending on the terms of the loan, it could be capitalized, which means it is added to the principal amount. You’ll want to review all the terms of the loan to ensure you’re aware of all the fees and costs associated with it.
Another essential aspect of construction finance is the budget. Before starting your project, work with a contractor or construction consultant to create a budget. The budget should include estimated costs for materials, labor, and other construction-related expenses. Having a comprehensive budget will allow you to more accurately apply for financing, as you’ll have a clear understanding of the costs associated with the project.
It’s also important to keep track of the funds being disbursed. Your lender will require you to account for every dollar spent on the project. You’ll need to provide payment receipts, invoices, and other documentation to prove that the funds are being used for their intended purpose.
One thing to keep in mind when it comes to construction finance is that it’s not a one-size-fits-all solution. Lenders offer different types of loans, and it’s essential to understand the terms and conditions of each type. Some may offer a fixed interest rate throughout the construction process, while others may offer a variable rate, which can fluctuate depending on market conditions.
Construction finance is a crucial element when it comes to building or renovating a property. Understanding the process and working with an experienced contractor or construction consultant can help ensure that your project is completed successfully and within budget. Take the time to shop around for a lender and review all the terms of the loan before signing on the dotted line. With the proper planning and budgeting, you can build your future without breaking the bank.
