If you’re reading this, you likely have a business looking to expand and wonder, “how do construction loans work in the new normal?” Or perhaps you’re a builder and hope to better understand the challenges in project financing during COVID-19.
Construction hasn’t been deemed essential in many localities. This is only one of many challenges you may be facing. But, believe it or not, now could be the best time to get financing so you can better position your business going forward.
Whatever your role, we want to help you navigate the uncertainty and take full advantage of the benefits of construction loans.
Here we will show you that construction loans are an excellent way to help fund capital projects for those short on funds. While these products are considered high-risk to lenders and have higher interest rates than other types, they work within short time frames.
Why Finance Construction Projects Under the New Normal
Business owners across the country are facing layoffs, downsizing, supply chain issues, and other hurdles that are sadly becoming commonplace. For those looking to make the most out of a rough situation, now may be a good time to position your business for brighter days.
A construction loan can help cover a project you may not have thought was possible.
Despite the challenges and risks, the real estate market is continuing apace due in part to historically low-interest rates. Now that appraisers, contractors, and builders are beginning to see how they can navigate the new normal, these projects are continuing. Construction financing can help you, and your business stay ahead even now.
How do Construction Loans Work?
There are two main types of construction loans, construction only and construction-to-permanent. We’ll go through the details of both.
How Do Construction Loans Work? Construction only loans
These types of loans are short term (12-18 months), have an adjustable rate, and need a substantial down payment of at least 20% of the construction cost. The project must be completed within the term, and borrowers could face hefty fees if the job isn’t completed on time.
This loan is better for investors who may not otherwise be able to complete a project.
Unlike a mortgage, because the property does not back this type, it represents more risk to the lender. The underwriting process includes the borrower providing detailed plans and timetables to the lender. The agent also uses these plans to evaluate the payment schedule and determine whether the project can be completed on time.
They can be used on all types of construction-related purposes but can not be used on real estate. Whether paying for contractors, labor, materials (inside and outside), and other associated costs, these products can typically cover the entire project.
The payment is released in draws to the contractor(s) as work is completed, and the interest is calculated based on how much is taken out of the total loan balance. That means that the initial payments will usually start smaller and end larger as payment is released.
It is important to note that it must be repaid in full at the end of the term, but refinancing is an option.
For these types of loans, the new normal will cause many changes in how the industry operates. Many banks and financial institutions are having a hard time when it comes to loans: they cannot lend to everyone, because most business owners have been permanently affected by the pandemic. This means most of them might not be able to repay a loan as they would’ve in the past.
Furthermore, financial institutions are also suffering financially and might not have the same liquidity as before. But thanks to government-backed loans, the economy has been able to survive. And while it may take a while to get there, the future could bring a new era of digital-based lending.
How Do Construction Loans Work? Construction-to-permanent loans
These products are essentially extended mortgages that cover the cost of building a home. This means that there is no refinancing once the job is complete. The lender converts the terms of a construction loan into a traditional mortgage after the property is built.
The best feature of this type, over a construction only, is that buyers can lock in a fixed rate ahead of time and have traditional mortgage terms usually ranging from 15-20 years. One downside is that a hefty minimum down payment is required. While it may be appealing to create a dream business space, it may not always be feasible for less qualified buyers.
Renovation loans usually have terms similar to construction-to-permanent products. Unlike personal financing for improvements or remodels, these types more holistic as they are usually used to cover multiple (or all) projects at once. The downside is that there is a more significant down payment required depending on the needed funds.
Because of the financial crisis caused by COVID-19, mortgage rates have reached an all-time low, which is a great opportunity if you’re looking for this type of financing. But it’s not all good news, there was a secondary effect caused by the pandemic: it’s harder to access these loans. Because lenders are very wary of losing money, they will not lend to just anyone during the pandemic and the new normal (the economy will take a while to recover), which means requirements will be stricter than before.
Risks Associated with Construction Loans
Whether you’ve been contracted to build a home or retail space or are trying to complete your own expansion for your business, it’s important to be aware of the risks and challenges in securing these products so you can be prepared.
- The project may take more time to complete than before, especially during the pandemic. This can be a particular issue for short term products with a 12-18 month deadline.
- The value of the property may decrease by the time the building is completed. If an economic crisis or recession arises from the pandemic, this will affect real estate and, with that, the value of properties. This can represent a problem for investors.
- The borrower may not qualify for the end loan. If the repayment to be carried forward past the variable rate term, it may be difficult to qualify for a consolidation loan or mortgage.
Challenges in Obtaining Construction Loans
Because of the uncertainty surrounding the pandemic, especially back in March, lenders have been holding back because of a lack of liquidity, which makes financing difficult.
Even now, there is still hesitation from some contractors and other construction-related professionals as to whether or not it’s ok to return to work.
Perhaps you have funds to complete the project but are concerned about cash flow as the virus lingers. Or maybe you’re a contractor or builder, and you’re having trouble getting projects off the ground.
Lenders have these same concerns, and thus financing can be a challenge.
Despite the interruptions at all levels of the economy, these products are still out there and can be a great tool to help your business expand and prosper.
In addition to all these types, owners may also qualify for a small business loan that can be used to cover construction-related projects. Maybe you’re looking to build a small warehouse on the back of your primary property, or need to repave and landscape the parking lot. Business loans have flexible terms and can be used for just about any need.
Why Consider Camino Financial Loans
At Camino Financial, we specialize in small business financing and can help you along the way. We thrive by offering solutions to small business owners like you. Our mission is to ensure that no business is left behind.
In addition to construction, we can help just about any owner with a small business product tailored to their needs.
Our application process is hassle-free and streamlined, with fewer requirements than the competitions. Our specialists will walk you through all the details.
Thrive in the New Normal
Construction loans can be a great way for those lacking in capital to continue to grow their business. The biggest challenge remains all of the uncertainty around the pandemic, and lenders may be hesitant. Even with these hurdles, financing is still available for your small business.