Construction is a complex process that involves multiple parties including builders, contractors, lenders, solicitors, accountants, quantity surveyors, and the council. With so many people involved in the process, there’s always the possibility of a communication breakdown and things may go wrong.
Getting approved for a building loan is half the battle with the majority of mortgage brokers and bank employees not understanding the process. Each lender processes a loan in a particular manner. With a conventional loan, it’s often easy to have the loan submitted and approved in a timely manner.
For a construction loan, this system is often poorly-designed and run by inexperienced staff within the banks. Loan documents are commonly lost and credit officers often lack communication skills, leading to misunderstandings and delays.
Our job as your mortgage broker is to fix these issues as they arise and, where possible, prevent them from occurring in the first place. No matter which lender you apply with, you’ll need to have some patience!
As a result, construction loans are often set-up with many errors. The loan amount may be incorrect or it may be delayed, due to constant amendments.
How Construction Loans Work
When you apply for a loan, the lender will need a copy of the building contract/tender and the plans.
They’ll ask their valuer to estimate the on-completion value of the property and will assess your loan on the lesser of the land price plus the cost of construction or the on-completion value.
If you’re building an investment property, some will even consider future rental income which can greatly improve your borrowing power.
Once your loan has been approved, the lender will issue a loan offer for you to sign and return, just like with any other construction loan.
When your builder is ready to begin receiving payments from the bank, he’ll need to provide additional documents, such as the final council-approved plans, his insurance, and the draw down schedule.
Preparing to Get Construction Loan
Preparing a construction loan proposal is, unfortunately, no easy task. Writing a loan proposal document requires time and effort — you need to collate the required details and paperwork, and you have to put them all together in a way that convincingly describes your business need to a lender and lets them know that your project is worth investing in.
So here are tips and tricks in writing a good and effective loan proposal to secure funding for your construction business.
Approach a local lender
When you have a big project that requires a significant amount of funding that you currently do not have, one of the first things that you can do is to approach a potential lender. The lender may be a private lending institution or a traditional bank.
It is quite important to approach a local lender, which means that the lending office or institution must be based in the same area or state where you will be doing your project. Not only will it be more convenient for you to transact with a lender that is accessible – a local lender will also have a better idea of the local market and will be able to assess your loan better.
Prepare a loan proposal
Once you approach a potential lender, the lender will typically let you know about their requirements. They will also ask you for general details about your project – what it is for, where it will be located, how long it will take to finish it, etc.
Beyond the general details, you will have to prepare a formal written loan proposal that is more comprehensive. This construction loan proposal is essentially your sales pitch to the lender. You want to convince them that your business is doing well, that you will be able to complete the project, and that you have a good back-up plan in case something does not go as intended.
Get the lender to review your loan proposal
A lender will review your bank loan proposal. Preliminary reviews are usually successful, and lenders can typically ask for supporting documents such as detailed building plans, construction timetables, or cost projections if you haven’t provided yet.
Note that it is also equally possible for a lender to not move forward with your loan proposal. Sometimes a lender does not see your project going as planned, or sometimes they already have a number of current loans in their portfolio.
When your construction loan proposal gets approved, expect to receive a term sheet from your lender. This term sheet explains the terms and conditions that the lender expects you to abide by in exchange for the funding that they will be providing to your project. You may agree or disagree with the terms.
Get the lender to appraise your project
Agreeing to the terms does not necessarily mean that you have secured the construction loan. Once you have accepted the terms, a lender may do an appraisal to assess the value of your project. The final agreement will be drafted based on the result of the appraisal.
A bank will also do a title search on the property. This will confirm if you have the right to work on the property and it will also identify potential issues with the real estate in question. Other types of assessments that a lender will do include a Uniform Commercial Code (UCC) filing and mechanics lien search against any of the property’s guarantors.
Close and sign the agreement
If everything goes well during the appraisal, your lender will issue a commitment letter and will draft the final loan documents. The loan agreement will present in detail everything about your construction loan, from how much equity is expected from you to how the payments will be disbursed based on the different project milestones.
When you sign a loan agreement, make sure that you are in full agreement with the terms that are outlined in the loan documents.
Things to Expect When Taking Construction Loan from Banks
Involvement of a lawyer
Dealing with a lender, especially if you are working with a traditional bank institution, requires some diligence in reading and going through legal documents. These construction loan transactions may be complicated and the processes and risks involved may not be as straightforward.
Hiring an attorney is highly advised. An attorney will be able to walk you through the construction loan process and will be able to guide you when preparing your loan proposal.
The process could take weeks or months
Getting approved for a construction loan does not happen in a few days unless you have been pre-approved. Typically, the construction loan process could take up to a few weeks to a few months, depending on which lender you are working with and how timely you are in complying with the requirements.
You are encouraged to prepare for a construction loan proposal early to ensure that you have the money right as your project is scheduled to commence.
Possibility of revising your initial proposal
Your final loan agreement may not have the exact same values that you outlined in your initial construction loan proposal. The results of the bank’s appraisal could result in your having to modify the contents of your initial proposal.
An appraisal of the project may, for example, find that your project is worth less than the amount that you are asking to borrow. If this happens, you have to justify your proposed loan amount or ask for a lower value. Be prepared to work on possible revisions.
How to Write Construction Loan Proposal
Writing a good and convincing construction loan proposal is critical if you want to secure funding from a lender. Here are the steps that could guide you when putting together your own construction loan proposal.
Prepare the required information
When preparing your construction loan proposal, these are some of the things that you have to think about:
- The amount of money that you need to borrow
- The types of construction services on which you will spend the money
- The method by which you will be repaying the loan
The considerations listed above should prompt you to collect and prepare the following information:
The estimated project costs, including construction budget, equipment costs, permit and municipal fees, etc.
- Project specifications and plans
- An outline of the expertise of your team or business
- A list of potential collateral that you are willing to pledge as loan security
- Compile supporting documents
The supporting documents could include the following:
- Business financial statements
- Partnership agreements
- Business licenses and registrations
- Articles of incorporation
- Purchase agreements
- Building plans and layouts
- Market studies
- Client testimonials and feedback
Note that the lender may require you to provide more documents other than those included in the list.
Follow an organized template
When writing your construction loan proposal, it is very important that you organize your document properly and ensure that the entire document is concise. You can use the following template to guide you:
Begin your construction loan proposal with an executive summary. Every formal business proposal has an executive summary that provides an overview of the content of an entire document.
An executive summary must include a short description of your company and the industry that you operate in. It also highlights your company’s strengths as a business, and of course, it gives a brief description of your business need, i.e. the nature of the project that needs funding and the amount of money that you need.
Before you go in-depth into with nitty-gritty of your new project that requires funding, you first have to establish what kind of company you are and the type of business that you do. In this part you present what your company is about and its key competitive advantages. You may talk about your company’s history as well as previous or current projects.
This is similar to the company profile, but it focuses on the people who are part of your company. This part presents the skills and expertise of your company’s management team and technical experts. Mention their qualifications and professional licenses. Keep in mind that your goal is to prove to the lender that your company has a capable team that would make your project a success.
In this part, you showcase the financial integrity of your company. The information that you include here should point to the appended financial statements. Describe your company’s current financial standing and also present the trend of your financial record over the last two to five years. The lender will look at your financial profile to assess your capacity in repaying a possible loan – put your company in a good light but remember to be transparent.
Project Information and Financial Need
This part details your business need: the type of project that you are working on, where it is located, what kind of services you need to accomplish this project, etc. All the information you present should lead to a reasonable estimate of the loan amount that you need.
Describe your proposed terms, including interest rates, term lengths, etc. In this part, you must also present how you plan to repay the loan as well as your project cash flow all throughout the project. The project cash flow should agree with your proposed terms. The goal here is to prove that you can repay your loan and that you have done your due research to anticipate potential financial pitfalls.
Pretty much all construction loans will require you to pledge collateral as security. In this part, you should include the collateral that you are willing to place to secure your loan in the event that you are not able to meet the construction loan terms.
These items are documents that may be appended to your construction loan proposal. They include personal and business financial statements, market studies, cash flow projection data, etc.
Getting a construction loan can help you save on your budget for more important matters in the future such as unexpected delays, errors, an increase in construction material prices, and so on. Assess whether your business needs it and when you do, follow our tips so you can write better proposals that are highly probable to get approved.