Funding usually means financial resources (mostly money, but it may also include skills and information) for the commencement or completion of a project. Construction projects are particularly big and expensive tasks that require a lot of time and a lot of capital. This means that at some point, you’ll have to seek funding. There are several ways you can go about this, and that’s what this article is all about.
What kind of funding do you need?
When undertaking a construction project, you need to seek funding for two different periods. Each of these periods has different levels of risk attached, and your understanding of them will advise your decision on what kind of funding to get, and how much you can you should seek. The two periods is the construction period and the post-construction period.
Even though there are other available options, the most easily accessible method of funding for these two periods are loans—a construction loan for the construction period, and a permanent loan for the post-construction period.
We will discuss the options for funding construction projects in a bit, but first, let’s look at these two loans and see what’s so peculiar about each of them.
What is a construction loan?
A construction loan is a short-term loan you take out to finance a building project. Construction loans are considered very risky, and so, they have higher interest rates than more traditional funding means like commercial loans. These loans usually have a duration of only one year, and Individuals take them out to pay for immediate project costs.
The way this works is that while construction is going on, you will only be required to pay the interest on the loan—the payment of the loan capital will come later. When you take out a construction loan, the sooner you complete construction, the lesser the interest on the loan will be. Sometimes, the lender pays the funds to the contractor instead of the borrower, and the funds are also paid in instalments as the project proceeds.
Considerations On Construction Loans
The first and most important thing to note about construction loans is that they have high-interest rates. Secondly, most lenders require you to make a down payment on your construction loans. In fact, most lenders require at least 20% to 25% down payment.
Another peculiarity of construction loans is that they can be quite difficult to get. Because you don’t have any collateral (your building project is incomplete), lenders may be sceptical about approving your loan. Some of the ways to circumvent this problem are to:
- Provide details on the construction project, including how every penny will be spent
- roof that a qualified builder is handling the project.
We will elaborate on these later.
What Is A Permanent Loan
Permanent loans as they relate to construction projects are also known as end loans, and unlike construction loans, they have longer terms. They are usually taken out to pay off construction loans and other short-term financing options. With end loans, the construction project is used as collateral after it has achieved “stabilisation”.
What Is Stabilization?
It is said that your construction project has achieved stabilisation when the facility becomes worth more than the construction cost. For example, if you spent £500,000 on the project, the project is said to have achieved stabilisation when it’s worth £600,000.
There is a much smaller interest rate associated with permanent loans than with construction loans. This is often because permanent loans have collateral (the facility) and a fairly stable means of repayment (rent, for example). In some situations, you can take out a loan that covers both periods (both the construction and post-construction periods).
How To Secure The Loan
Knowing the kinds of loans, you need to finance your project is just the beginning of the hurdle towards securing financing. You also have to make sure that you actually get it. When approaching a lender for a construction or business loan, you can strengthen your case and ensure your loan is approved through the following ways
Prepare Your Plan
As mentioned earlier, getting all your ducks in a row can increase your chances of getting an approval. Since you can’t provide collateral as proof of your repayment, you have to provide something else—a plan. You should have a well-defined project plan, and update it as new developments arise. You also want to develop your plan and start seeking funding as quickly as you can because it often takes a while to secure funding.
Get The Right People
Another thing lenders consider when evaluating your application is the team you have on the job, particularly the contractor. Some lenders even prefer to pay the contractor the funds directly and in instalments as the project progresses. It’s much easier to get a lender on board if you have recognised and reputable people on your team. The opposite is also true.
Get Some Tenants
If you need a loan to upgrade or improve an existing facility, it would be much easier to secure a loan if the facility were occupied, as compared to if it were empty. The rationale is pretty simple, and it goes that a tenant occupied facility has clear means of cash flow, and a means for you to repay the loan.
Conversely, an empty and unoccupied property can’t prove its ability to service a loan. In some cases, lenders like banks won’t even approve a loan on existing facilities until you achieve up to 60% occupancy on it.
Other options for funding a construction project
As you can see, securing funding for your construction project can be a very difficult task, especially if you aim to secure the funding via loans. If you’re unable to get your loan approved, other funding alternatives include:
- Commercial loans
- Small Business Association (SBA) loans: If you’re operating under a business, this may be a great alternative for you. Small business loans are backed up by the government, and often have better terms and lower interest rates than other loan options.
- Line of credit: A line of credit operates a little like a credit card. An amount of money is made available to you, but you only take what you need from it.
So Can You Get Funding For A Construction?
The answer to this question is a resounding yes. You can get funding for a construction project. In fact, you have several options and can take your pick based on your preferences and personal situation.