How does construction finance work?


The price of residential property is increasing day by day, meaning that many people feel priced out of the market altogether. Therefore, it is no surprise that the amount of people looking for a construction loan is much more than before. You have to look for alternative sources to buying a place or moving, and the best possible solution in such a scenario is construction finance. In this article, we look at how construction finance work and what are its basics.

What is construction finance?

Construction finance is a type of loan that is suitable for people who want to construct their own building, home or office, instead of buying a property that has been established. It also has a different loan structure than the other types of home loans as you are actually starting everything from scratch and the needs are different from what you have for a developed location. Therefore, a construction loan is a unique option for lenders or builders to help them do the job. The amount available for usage will depend on the evaluation of the location, the total costs analysis that shows the money needed for the construction work. 

How does construction finance work?

You do not get a lump sum payment for these loans like other options, instead, the lenders have fixed payments which can either be in installments or on the completion of a stage during the construction. This is one of the main requirements of the loan providers so that they ensure the money is being spent on the actual task. Generally, there are five primary stages of payments that start from the pouring of the foundations, framing, brickwork completion, locking up and the final construction completion. 

Most of the lenders will appoint a person who will take care of all the construction work along with you and will also help in making sure you spend the money in the right places. Therefore, the construction loan payment is progressively drawn-down. That is, you increase or decrease the borrowing as needed to pay for the construction process. The interest is charged only on the rate that was decided and the first payment you have drawn. For example, if the total loan was of £300,000 and you have withdrawn only £50,000 initially, then the interest will be charged on the £50,000.

What is the payment breakdown?

As stated earlier, the payments are made in five different stages once the loan has been approved.

Slab pouring is the first stage and the amount paid here is to help with laying the foundation of the building and covers the levelling the ground, the plumbing systems and the waterproofing procedures. 

The frame is the second stage, and the money here helps with the building the framework of the property, some of the main things covered with this cash is brickwork, trusses, windows and roofing.

Lockup is the third stage of the payment in which the money helps with the covering of the property, usually the outer walls that will come with windows and doors. The next stage of payments helps with the internal fittings and equipment of your property and covers a wide range of things such as the plasterboards, cupboards, benches, plumbing, electricity, sewerage and other things. The last stage is the completion where the amount for the conclusion of items such as building equipment, finishing touches, wiring and cleaning is covered to ensure that everything is done correctly.

Advantage of construction finance

One of the main benefits of construction finance is the security it provides with the construction work. The lenders release money periodically, which means that the contractor will not be paid for something they haven’t even done or isn’t up to the standards. Having a lump sum payment in your hands can also lead to the cash being spent on something other than the actual task at hand.

The interest rates are much less than the other options. You will have a fixed amount that you can withdraw during the duration of the loan, but the interest rate will only be charged on the money that you are actually using and not the total amount. It is a significant advantage for people with less resources than others as you save money during construction.

Another advantage is that the loan is interest-only during the construction period which means that you only have to pay the interest during that time and the total balance remains unchanged. It helps with the cash flow during the work and is useful if you have to rent somewhere else during the time of installation.

Disadvantages of construction loans

There is a lot of paperwork and requirements to be fulfilled before you actually get your hands on some cash. The loan providers require several documents and building plans approved by the city council before they can make any decision. They might also want to see your credit history, and he fixed price building contract to approve the loan, so you have to spend a lot of time and effort before the final result.

The construction loans have higher values on the deposits especially if you are doing all the work yourself along with owning the building so you will have to pay a large deposit to make sure the loan is yours. Another disadvantage here is that the payments can be delayed because the lender wants to be satisfied with the progress before releasing more money.

Lastly, the interest rate on the overall payment is still higher than the usual home loans during the construction but does go back to the standard charges once the building is completed.

All in all, there are several different options out there if you are looking for a construction loan, getting an idea about how does the construction finance work is just the first step, you have to evaluate your situation, look at all the pros and cons and then reach a final decision that best suits your requirements.

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