What To Consider Before You Get A Construction Loan

by Tim Bullen on December 13, 2011

Some property owners, buyers, and builders seek financing for the purposes of construction. They may have a project and look into different sources of construction financing, as well as how financing works. A second category is formed by persons who have done some research and have specific questions in need of an answer. Those who have found sources of financing make another category. In all cases, there are some factors to keep in mind. These are timing and management of cash flow which should be factored in before applying for financing. Construction projects have impact on the cash flow of builders, lending institutions, borrowers, suppliers, and service providers. For this reason, it is important to outline accurate payment timelines, completion stages, budgets, and disbursement requirements.

Similar to other types of financing, construction loans have to be secured by some asset. In case the equity in the underlying property is insufficient to cover the project’s first draw, the borrower can take out a second mortgage. Over the next stages of construction, the property’s value will increase, and more funding may be available at specified stages of completion.

The points of completion or milestones are determined at the start of the project, and they reflect the timeframe over which the fair value of the building is expected to increase. If we speak of a residential property, the completion of the foundation and basement will be typically considered the first milestone. The enclosure of the roof and walls and the framing of the building will be the next milestone

With some lenders, construction loans have the following characteristics. First, money is available when required, and the principal amount is not due until the construction project is complete. This takes a period of 18 months from the time construction has started. The loan can be converted into another loan type with a fixed rare upon completion. Interest that was accrued during the different construction phases may be capitalized into the loan amount.

One important factor is the benefits of taking out a construction loan. With funding available when required, borrowers save on interest. In addition, borrowers find it easier to manage their cash flow over the term of the construction loan. Meeting unexpected expenses is less problematic. Borrowers get a good deal because of the option to convert the loan into another fixed loan product as well as the competitive interest rates.

Naturally, there are different types of loans. They are either part of a so called combination loan or are in the form of a stand alone bridge loan, offered for the period of construction only. The combination loan starts out as a construction loan, then rolling in into a long term mortgage loan, which is pre-approved.

Finally, it should be noted that as the complexity and size of the project increase, so do the lending requirements of financial institutions.

Mortgage guide in Canada can be confusing, and lenders option are here to help.

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