What is a Private Construction Financing?
Construction loans are generally short term financing loans for business owners looking to finance and to provide working capital to appropriate funds in the case that the company would like to procure a new real estate project. Usually speaking, the pay back terms on a construction loan range from twelve for twenty-four months. The terms and conditions of this financial instrument depend upon a number of factors, including but not limited to: length of time in business, monthly revenue, P and L Sheet (profit and loss sheet), and many other mitigating factors. Due to the fact that the construction loan is a non-collaterized loan, there may be other documentation needed to validate one’s, monthly revenue, for example.
Upon closing, one can utilize the company’s exceptional accounting and bookkeeping services to ensure that the funds are being appropriated correctly. For example, once the property is paid for by the loan officer, the remaining balance may be safeguarded in an escrow account.
Who Are Private Construction Financing For?
Construction loans are mainly utilized for builders who may decide to build or to”flip” prospective property in order to increase their Return on Investment (ROI). Technically speaking, in order to work on a new project an investor may not have the capital to invest in a new project, when the opportunity arises, so they will pay a nominal fee to get another property without having to take funds out of one’s own pocket. Most often, construction loans are used to quickly and seamlessly finance the construction of single or dual-family homes, apartment buildings, or subdivisions.
Unfortunately, construction loans are not available to assist one with building their dream home. For owner-occupied borrowers, a construction-to-permanent loan might be a more suitable option.
What Types of Construction Projects Qualify?
Construction loans can be used for all types of many reasons including but not limited to the following: construction projects, residential, commercial, industrial.
Although, construction loans are most often used for construction or renovation of single family properties, they can also be used for condominium projects, multifamily complexes, townhouses, subdivisions, and commercial projects.
What are the Benefits of a Private Construction Loan?
The three main benefits of private construction lenders are:
- Speed to Close
- Flexible Underwriting
- Asset Based Lending
Whereas traditional lenders require borrowers to go through a long and arduous approval process, private construction loans are asset-based with much less documentation.
Hard money lenders base their approvals on the terms of the deal the borrower’s experience, and the borrower’s credit score.
Borrowers are not required to submit tax returns, proof of employment to qualify or take income ratio into consideration. For this type of loan, the lender will usually only require one or two bank statements to verify the borrower has enough cash to close.
While traditional loans can take 3-5 months to approve a construction loan, private lenders can approve and fund hard money loans in a fraction of the time, usually a couple of weeks, and without all of the paperwork that traditional financing requires.
How do I qualify for a Hard Money Construction Loan?
Construction loans are intended to finance the construction of a project or “go vertical.” In order to qualify for a construction loan, the property must already be entitled for the type of building that the real estate investor wants to construct.
In order to get approved, the borrower will need to have completed architectural plans, engineering, budgets, and a scope of work. Plans, engineering, and fees are generally referred to as “soft costs” and some lenders will allow the borrower to finance those into the overall loan.
Once the borrower has the necessary plans and entitlements, they will fill out an application with a hard money lender. In addition to the application, the lender will want to know the borrower’s credit score, any previous experience, and the plans and scope of work for the project.
Based on that information, the lender will then issue a term sheet to the borrower that outlines the loan terms under which the lender is prepared to offer a loan. These terms can vary, but usually range between 70% and 85% LTC (Loan to Cost) based on the overall project budget. This means that the borrower will be responsible for paying closing costs as well as 15% to 30% of the cost of construction.
Once the borrower accepts the terms, the lender will order an appraisal of the property from a licensed appraiser. While the appraiser is conducting the appraisal, the lender collects any outstanding items and makes sure the file is complete. Once the appraisal is compete and approved, the lender will complete the final underwriting and fund the loan.
How Are the Loan Proceeds Disbursed?
During the underwriting phase of the hard money loan, the builder provides the lender with a scope of work and budget that breaks the project down into phases and specifies how much each phase will cost and how long it will take. All of this is determined in the Draw Schedule.
Later, as each phase of construction is complete, the borrower contacts the lender to inform them that a phase has been completed. The lender then orders an inspection by a 3rd party company who visits the property and verifies that the agreed upon work has been completed.
Once the inspection has been completed and the work verified, the lender reimburses the borrower for the outstanding construction costs. The entire draw process usually takes about 3-5 days to complete.
How do the Payments Work?
Although there are many types of loans, it is important to note that this is not like a traditional mortgage where payments are amortized and consist of principal and interest. Hard money loans are generally interest-only, which means that the monthly payment is just the interest due on the loan and does not decrease the overall loan balance.
The payment can either be setup as Dutch, where the borrower pays interest on the full amount of the loan, or non-dutch (also known as “New York Interest”) where the borrower only pays interest on the amount of the loan that is disbursed. When evaluating your financing options, it is important to find a lender that offers non-dutch payment options.
What to look for in a Construction Loan Lender
There are many hard money construction lenders out there. In general, finding a reputable hard money lender is no different than any other business. Check their website to see if they are licensed by their state and the NMLS. Also, see which trade groups and organizations they belong to. The American Association of Private Lenders (AAPL) is a good one to check with.
Most importantly, work with a lender that you trust. Most private construction lenders will have similar terms, so it really just comes down to working with someone that you feel comfortable will be transparent, honest, and will treat you right.
Take a look at their reviews on Google and Facebook to see what their customers have to say. Try and stay away from private lenders that charge large up front fees before the approve your loan. It is customary for the borrower to pay for the appraisal, but other than that, most lenders do not usually charge any upfront fees just to review your loan.
Is a Hard Money Loan Right for Me?
If you need to borrow money for a ground up construction project and want to avoid the headaches of dealing with big traditional banks, private construction loans can help you raise the cash you need, save you valuable time, and offer flexible terms.
Whether you are building a single house or an entire subdivision, experienced real estate investors know that private financing allows them to focus on building their projects without worrying about red tape, lengthy approvals and endless paperwork.
If you have any additional questions about real estate investing that weren’t covered in this article, please see our FAQ for additional resources and information. You can also learn more about our loan programs or contact us directly for more information.