Construction companies and individual property developers alike make use of construction loans to build new homes. A construction loan is similar to a traditional mortgage, yet a bit more complicated. The extra complications are a direct result of having more to worry about – from land purchase to actual building and then the sale of the finished house.
Though it might surprise you, construction loans are not so easy to come by. A lot of banks and private mortgage lenders are reticent to look at construction loans unless they are presented in just the right way. In the absence of the right kind of presentation, lenders have plenty to worry about. Their three biggest worries are explained below.
1. Unreasonable Risk
If there is one thing that must be understood about financial services, it is this: risk is part and parcel with every loan offered. Regardless of the amount being loaned and to whom the money is going, banks and private lenders take a huge risk every time they approve a loan package. Construction loans are no exception.
Lenders have to look at every construction project and determine its relative risk as best they can. If they deem that a given project represents an unreasonable level of risk, they are not going to approve a mortgage. On the other hand, if the risks are low and the potential rewards high, a construction loan is likely more forthcoming.
Suffice to say that risk is the single biggest factor to influence construction loan decisions. If the risks are too high, lenders walk away.
2. Lack of Experience
The next thing lenders fear is a lack of experience. This explains why developers embarking on their very first projects struggle so much to find financing. Lenders don’t want to touch newbies because their lack of experience could wind up causing big problems.
There is a lot to be said about experience in the construction industry. Experience is a great teacher when it comes to estimating costs, projecting timelines, and so forth. A lack of experience just increases risk. It can lead to cost overruns and delayed construction. It can result in a house not selling at a high enough price to cover financing.
Lenders like to see a history of successful projects even when a builder or construction company applies for funding through a partner like The Mortgage Broker. According to this mortgage brokerage, the chances of being approved for construction loans goes up with every successful project a construction company completes.
3. Unpackaged Mortgage Applications
Last but not least are those construction companies and builders who go directly to lenders in search of financing. This worries lenders because they are being presented with unpackaged mortgage applications. An unpackaged application demonstrates that a builder may not fully understand what he’s getting himself into.
A packaged mortgage application covers the entire process from start to finish. It covers land acquisition, land development, building construction, and eventual sale. It covers all of the known costs of seeing a project through to the end. A packaged mortgage application is also built around the standard three-stage lending schedule.
Using a Mortgage Brokerage
All three of these worries can be mitigated by using a mortgage brokerage rather than going directly to the lender for construction loans. Brokerages hire experienced brokers who know what it takes to get construction loan applications approved.
Understand that mortgage brokers, at least in the UK, are financial advisers with a speciality in mortgages. This means something in the construction industry. It means that the experienced mortgage broker can walk a builder through the entire financing process, accounting for every expense every step of the way.
That mortgage broker can also create the kind of packaged loan application lenders want to see. This gives lenders confidence that the risks are low; that the broker has considered the builder’s experience and history; that all of the costs associated with the project have been correctly estimated and properly accounted for.
Construction lending is risky business. In order to mitigate those risks, lenders prefer that construction companies and builders go through mortgage brokers to arrange financing. That is just the way the system works.