Construction loans and finance

Constructing a new building or re-developing an existing property to sell for a profit, use for your own needs, or rent out for income, can be a successful financial strategy.

A South African property is almost always in demand. However, building buildings is not cheap. Large upfront costs to cover land, materials and labour will be incurred, and meeting these costs can put a major dent in any business cashflow. Fortunately, there’s a solution to this problem – meet the construction loan – a purpose-built financial product that lets you fund the cost of building without demolishing your bank balance.

What is a construction loan?

Construction loans, (also known as development loans), are a type of bridging loan used to cover the costs of building new homes and commercial premises or re-developing existing residential and commercial properties. Construction loans may also be used to buy a plot of land to build on or purchase an existing property for re-development.

How do construction loans work?

Constructing or re-developing a property is a capital-intensive task. Large upfront costs to pay for land, planning, construction materials and labour will be incurred. These costs must be met before the property can be re-sold or used to generate income. Additionally, because the property may not exist yet, (it’s a new-build), or it will undergo significant change, (re-development), it is very difficult to secure a traditional residential or commercial mortgage to pay upfront costs. Instead, builders, businesses, and developers will use a construction loan to cover the project’s initial expenses.

Construction loans are always short-term, usually 12 – 18 months depending on the scope of the project, and are usually repaid when construction is complete and the property is re-sold or re-financed with a mortgage. Where the loan must also cover the initial purchase of the site or plot, the maximum amount that can be loaned is typically between 50%-60% of the purchase price of the property. Sometimes lending of up to 100% of the build costs can also be provided, as long as the total amount requested is within 60-75% of the estimated value of the project when complete.

Fees, interest rates and the terms and conditions of construction loans are usually agreed on a case-by-case basis, so costs can vary considerably. Funds are usually released to the borrower in stages as the project progresses. In all cases, the lender will take a legal charge over the property as security.

What types of construction loans are available?

There are different kinds of construction loan:

Construction-only loans

Suitable for all commercial and residential projects.

This type of loan only covers the purchase of land or an existing building and the costs to build new or re-develop the existing property. Once the project is complete, the loan must be repaid. This can be done by either selling the property or replacing the construction loan with a traditional commercial or residential mortgage.

Construction-to-permanent loan

Suitable for commercial and residential projects, but mainly used for home construction.

Construction-to-permanent loans provide funds to buy land or an existing property, plus the costs of building new or re-developing the existing premises. Once the project is complete, the loan is converted to a permanent commercial or residential mortgage. This type of financing may cost less than a construction-only loan, as the borrower only incurs one set of fees at the beginning of the project.

Owner-builder loan

Suitable for residential projects.

Owner-builder loans are for homeowners want to build a custom home themselves and they act as both builder and borrower. The loan can buy land and an existing property, plus cover the costs of construction to build new or re-develop the existing house. Due to the complexity involved with building a home, most lenders will only provide this kind of loan if the borrower is a licensed builder. The loan may be paid back when the project is complete or converted to a traditional residential mortgage.

Renovation loan

Suitable for all commercial and residential projects.

Businesses and homeowners seeking to upgrade their property can use a renovation loan to cover costs. Small projects can often be paid for with a personal or business credit card . Larger renovations could be funded by refinancing an existing commercial or residential mortgage, or combination financing, such as a mix of asset-finance, unsecured business loan, and a construction-only loan.

What are the advantages of a construction loan?

Construction loans offer several advantages for businesses undertaking building projects:

Flexible financing: Construction loans provide borrowers with flexible financing options for the specific needs of their construction project. Borrowers can typically access funds as needed throughout the various stages of construction, which helps manage cash flow.
Interest-only payments: During the construction phase, borrowers typically make interest-only payments on the amount drawn from the loan, rather than paying principal and interest. This can help reduce the financial burden during the construction period.
Control over costs: Construction loans provide borrowers with control over costs by allowing them to draw funds gradually as construction progresses. This helps prevent cost overruns and ensures that funds are allocated efficiently.
Customised terms: Lenders often offer customised terms and repayment schedules for construction loans, taking into account factors such as the project timeline, budget, and borrower’s financial situation.
Conversion options: Once construction is complete, borrowers may have the option to convert the construction loan into a traditional mortgage or long-term financing arrangement. This simplifies the transition from construction to permanent financing and eliminates the need to secure separate financing for the completed property.

What does a construction loan cover?

Construction loans can be used to pay for:

Land
An existing property for re-development
Permits and planning applications
Construction materials
Construction labour
External services, such as architects and engineers

Eligibility requirements for a construction loan

Eligibility requirements vary from lender to lender, but most will ask the borrower for the following:

Credit status: A healthy credit score is beneficial, but it’s not always necessary. Even if you’ve been turned down before, it may be possible to secure the construction loan you need.
Sufficient income/cashflow: Lenders need to know that you can cover fees and interest payments until the construction loan is repaid by selling the property or re-financing it with a traditional mortgage.
Cash deposit: You must show the lender that you have funds to pay the deposit – which will be 25% of more of the project cost.
Project plan: Lenders will ask for a detailed proposal supported by documentation. This may include:
- The deed for the property
- Comprehensive designs and blueprints of the development
- Realistic budgets
- A proposal for drawdown of funds, with clear milestones
- Construction contracts with approved suppliers
Exit strategy: How will you payback the construction loan? If you intend to refinance with a commercial or residential mortgage, lenders may ask for your pre-approval letter.

The application process for a construction loan

The application process for a construction loan can be lengthy and will require the borrower to submit a substantial information package. Although most construction loan requests are considered on a case-by-case basis, the basic application process is the same for all projects:

The lender reviews the business plan of the development. This includes the estimated costs and proposal for release of funds, as well as information on the applicant’s financial background and any experience within the building and construction industry.
The lender analyses the information provided and carries out standard credit checks.
If an application is successful at this stage, an agreement in principle is issued.
Lender undertakes a site visit to ensure project viability and arranges an independent valuation of the project. Should the results of these investigations be sufficient, a formal loan offer and terms are issued.
Contracts are exchanged, followed by the completion of the loan.
First stage payment is released.

How to find the right construction loan for your business

Finding the best construction loan for your business and going through the application process can be a lengthy, costly, and time-consuming process. Whereas individual lenders may only have a limited suite of loan options, using a broker such as Swoop can give you access to multiple lenders with just one application. The broker route can also save you time and money, provide the largest choice of loan products, and give you the most competitive rates and fees.

Get started with Swoop

Constructing a new building or re-developing an existing property can be challenging enough. The last thing you need is a difficult loan application process too. Take the headache out of securing the best construction loan for your business. Get started with Swoop today to start building your next big thing.

Testimonials

Swoop was amazing! I was looking for refinancing and they were straight onto finding me the best possible option. I would highly recommend them.

Laree Smith

Owner, F45 Cambridge

Written by

Chris Godfrey

Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Barclays Bank, Metro Bank, Wells Fargo, ABN Amro, Quidco, Legal and General, Inshur Zego, AIG, Met Life, State Farm, Direct Line, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of consumer and business finance and insurance.

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