If you're looking to build or rehab real estate property and intend to refinance it to generate rental income or sell it for a profit, a construction loan might be the best option. Since most people can't afford to pay for the cost of a new commercial or residential project up front, the process of securing a construction loan typically begins with a lender: local credit unions or regional banks. Unlike a conventional loan, however, it’s more complicated to get the green light on your construction loan application because you’re essentially requesting to borrow money for a new build that doesn’t exist yet.
This post outlines some of the requirements you need in order to qualify for a construction loan.
Qualifications For A Construction Loan
Since the bank or lender is lending money for a real estate project that is yet to be built, they tend to be a bit leery in granting this type of loan. As a borrower, not only does your trust fall in the hands of a qualified builder to do a good job, but once the property is completed it needs to have a certain value for the bank to deem it a good investment. To protect themselves from such risks, banks include these provisions:
1. The Lender Needs Detailed Descriptions. Also known as the “blue book”, you’ll need to provide a list of details that generally include everything from floor plans, cost and profit projections to a timeline of the anticipated project and an inventory of materials that are going to be used, suppliers and subcontractors.
2. A Qualified Builder. In order to get an institution to finance your project, you must have a reputable and licensed builder. Unless you intend to be your own general contractor or build the home with your own hands (which involves a different type of loan), you need to include a list of the builder’s current and past projects along with a profits and loss report.
3. A Down Payment of Minimum 20%. Some lenders can ask for as much as 25% - this ensures that you’re able to carry out the cost of construction, even if things go south.
4. Proof of Your Ability to Repay Loan. The lender will request to see proof of income and good credit.
5. The Property Value Must Be Appraised. The loan qualification criteria is based on the value of the finished product. Appraisals are location-specific and depend on market conditions.
How Construction Loans Work
Your loan application starts off as a short-term loan used to cover the cost of building property from the ground up. Once it’s finished, the borrower will enter a permanent loan (also referred to as the “end loan”) to pay off the short-term loan. At Walnut Street Finance, we fund projects on a short-term loan ranging from six months to a few years, after which the loan is repaid when the construction is finished and it’s been sold or refinanced. Whether your project involves rebuilding an entire home, renovation or constructing a home or commercial space from the ground up, we work with borrowers and their timelines to facilitate a construction loan designed to their project’s specifications.
Do you have any burning questions about an upcoming project or the real estate industry? We’re here to help.