Funds which are utilised to bridge the gap between work completed and payment for that work is commonly referred to as construction finance. Construction companies in the UK need flexible finance as they are under tremendous pressure to meet the housebuilding targets set for them by the government.
Extended payment contracts and late payments are some reasons why construction firms fail to keep up with demand. Infrastructure projects and housebuilding will not be stalled and the target of building 300,000 new homes will become realistic to achieve only when construction companies will have easier access to construction finance.
As the construction industry functions in a different way compared to businesses in other industries, it requires an entirely different type of financial product. In this guide, you will find answers to several questions that you may have such as how to become eligible for construction finance and how it works.
How Does Construction Finance Work?
In simple terms, construction finance allows construction companies to hire equipment, purchase the materials they require for construction, pay contractors and also helps to keep cash flowing. Big construction companies can manage these financial responsibilities without additional finance, but for small construction companies it means the difference between a stalled and successful project.
One of the best features of construction finance is that it allows businesses to access the much needed funds which are locked away in outstanding invoices. With construction finance a construction company does not need to wait for their clients to pay them. It is also known as construction factoring.
It eliminates the anxiety and the shortage of funds that business owners need to face when they do not get paid for their invoices for months. It can also be used for partially completed work and payment applications. A construction loan is essentially a form of prepayment by the lender.
Similar to other types of credit, a number of factors are taken into consideration before the loan is approved such as outstanding debt, credit history and credit score. When a loan application is successful and a company has been approved for a construction loan, the lender begins to pay out the money as per agreement. Instead of advancing the entire credit amount up-front, a schedule of draws is set up.
Designated intervals at which a builder is provided the funds which are needed to continue with the project are known as draws. Throughout the duration of construction, there may be several draws. For example, the first 10 percent of the loan amount may be advanced when the loan closes and the next instalment of 10 percent upon laying the foundation of the building.
The subsequent instalments will be provided at predefined project milestones such as completing the construction of a certain number of floors, when the roof is laid and upon furnishing the interiors. The number of instalments and the amount of each is borrower and the lender. The borrower’s down payment is used by the lender for the first draw as it puts the borrower’s money at risk. An inspection may be carried out by the lender before each instalment is released.
Construction Loan Rate
As with any other type of credit, interest needs to be paid on the money borrowed in the form of construction finance. The interest rate differs from lender to lender and they are usually variable rate loans, which means that different interest rates may be applicable at different stages of the construction.
Also interest is not payable on the entire loan amount but the amount which has been already withdrawn. For example, if only £10,000 has been borrowed from the approved loan amount of £100,000, then interest needs to be paid on the first instalment of £10,000.
Am I Eligible for Construction Finance?
Banks are often apprehensive about approving loans for small construction companies owing to the high level of risk involved in construction projects. However, there are several alternative finance companies which are willing to extend credit to companies based on their ability.
Builder Must Have Experience
Getting approved for a loan becomes a lot simpler if the builder has successfully handled construction projects in the past. A reputation for building quality projects will help a loan applicant to stand out from the rest. First time builders may find it difficult to convince a lender to fund their project, but as we mentioned earlier there are many providers of alternative finance which may approve the loan applications of such builders.
The lender may request the loan applicant to provide details which are important to the project such as the materials which will be required for construction and floor plans. Floor plans include elaborate information relating to the project such as type of home insulation which is to be used and the height of ceilings.
An Appraiser Must Estimate the Building Value
The lender will certainly be interested in knowing the final value of the building upon its completion. It may seem difficult to place a value on a structure which doesn’t exist yet, but surveyors can easily accomplish this task based on the specifications provided to them by you and taking similar projects of a similar scale at similar locations into consideration.
Some lenders may even ask you to put down a minimum amount for a construction loan and it generally corresponds to 20 percent of the approved loan amount. It gives the lender assurance that the builder is committed to the task of completing the project and that they won’t abandon the project if things do not proceed as per plan. It also protects the builder from other unfavourable outcomes such as a slowdown in the real estate industry or the possibility that the building does not hold as much value as it was expected.
If the above criteria are met by your construction company and you also have a good credit history and credit score, the chances are quite high that your loan application may get approved.