New construction investments have a lot of appeal in today’s competitive real estate market. With the U.S. experiencing a shortage of somewhere between 4 and 6 million homes, new construction presents a lucrative opportunity for investors while also delivering much-needed housing to underserved markets.
Financing a new construction project, however, is a different ball game from obtaining a mortgage on an existing home. Along with having different requirements, there are a variety of loan options, each with its own pros and cons. This article covers the basics of new construction financing, the different loan types available, and tips on how to approach funding a construction project from a wholesale perspective.
Understanding New Construction Financing
New construction loans have a few key differences from traditional mortgages. Since standard mortgages are used for purchasing properties, all funds are typically distributed at the time of the purchase. In contrast, while there is a total loan amount with construction financing, funds are distributed in a series of disbursements called draws. Each draw serves a different purpose, such as covering framing, windows, electrical work, and plumbing, each receiving a dedicated percentage of the total loan.
New construction loans tend to have higher requirements, especially for credit, as there is no collateral to back the loan in the case of a default. This is where working with a wholesale lender can benefit real estate professionals, as they may offer more flexible terms tailored to investors. Wholesale lenders often provide access to competitive rates and larger loan amounts, which can be crucial for new construction projects that require substantial capital.
Construction-to-Permanent Loans
Construction-to-permanent loans are exactly what they sound like: these loans cover the initial cost of constructing a property and then can be easily converted into long-term financing. The main advantage of this type of loan is that there is only a single closing process the borrower has to go through, which can bring savings. Lenders may also allow you to lock in a rate for the long-term loan ahead of time, which can bring additional savings, especially if you predict that interest rates will increase during construction.
For wholesale investors, construction-to-permanent loans are an excellent option if the goal is to hold on to the property after construction. You won’t have to go through the added hassle of securing a separate loan once construction is complete, and you’ll have a seamless transition from the construction phase to the permanent financing phase. This type of program works best if the property will be held for rental purposes, or if you anticipate that long-term financing options will not be favorable post-construction.
Standalone Construction Loans
Standalone construction loans are essentially the opposite of construction-to-permanent options. They only cover the costs associated with the construction of a property and will require a separate loan if you plan to hold on to the property afterward. These loans can be a viable option if you’re planning to sell the property immediately after construction finishes or if you expect that you’ll be able to secure better terms for permanent financing after the project is complete.
However, you should understand that this strategy can end up costing more. You’ll still need to go through a second application process with its own set of closing costs and fees, and you might end up with a higher interest rate than you initially anticipated. For real estate professionals working on multiple construction projects, this approach can quickly eat into margins, making wholesale financing solutions a more cost-effective strategy.
Private Lending for New Construction
Another option you have is working with a private lender who specializes in new construction projects. Private loans offer many benefits, including more flexible terms and a faster approval process, which can be crucial if time is a factor. These loans also typically have a less stringent application process where your creditworthiness is less of a factor, and the financial potential of the investment is used to determine approval. This makes private lending an attractive option for investors who may have a history of success in real estate but have less-than-perfect credit.
When selecting a private lender, be sure to choose a reputable partner with a proven track record of delivering financing for real estate projects. Private lenders often work with both seasoned developers and first-time investors, making them a versatile financing solution. However, be cautious of the higher interest rates that tend to accompany private loans. Comparing various loan options is crucial for securing the best terms for your investment.
Preparing for the Loan Application
As we mentioned, obtaining approval for a new construction loan can be more challenging than securing financing for an existing property. It helps if you are well-prepared before you start applying for financing. This typically means having a written plan for your project, along with a detailed budget, income/bank statements, and evidence of the permits you’ll need to proceed.
Most loans require a good or excellent credit score, unless you are applying for a private loan. You should also expect to place a down payment of at least 20%, as there is no collateral to back the loan. Additionally, lenders often require that you have all plans and permits in place with your local jurisdiction before the construction phase begins, which can add time to the process.
If you're working with wholesale lenders, they often provide additional resources to help streamline the loan application process. They may offer financial tools or even specialized advice to help you present the most compelling case for your project. Having a clear budget, detailed timelines, and reliable documentation can help improve your chances of securing financing.
Managing Your Loan During Construction
Once construction begins, you’ll need to maintain open communication with your lender to ensure a smooth process. This is where having a thorough plan and established relationship with your lender proves invaluable. As construction progresses, you’ll need to request draws for each phase of the project, and many lenders require inspections to ensure the project is on schedule.
For real estate professionals, working with a wholesale lender during this phase can be especially advantageous. Wholesale lenders typically offer a streamlined process that keeps things moving forward smoothly. If delays occur, it’s important to keep your lender in the loop and request an extension or adjustments as needed.
Lenders may also monitor the progress of your project before releasing additional funds, and a delay in construction can sometimes result in a temporary freeze on disbursements. Make sure you have contingency plans in place to address any unexpected challenges during the build.
Wholesale Financing Options: Why It Matters
For real estate investors, especially those working on multiple construction projects, accessing the right kind of financing is essential. Wholesale financing offers significant advantages, including access to better rates, larger loan amounts, and more flexible terms. Wholesale lenders can often provide tailored loan solutions that are not available through traditional financing providers, giving investors the leverage they need to take on larger and more complex projects.
In the competitive landscape of real estate, securing a reliable and affordable financing option can make all the difference in the success of your project. Wholesale lenders are typically more adaptable and focused on building long-term partnerships, which is especially valuable for developers or investors looking to scale their operations.
RCN Capital
Financing a new construction project requires careful planning, thorough research, and selecting the right type of loan. Whether you're opting for a construction-to-permanent loan, a standalone construction loan, or are focused on private lending, understanding the pros and cons of each option will help you make informed decisions. Real estate professionals and investors can also benefit from working with wholesale lenders who offer tailored solutions, better rates, and flexible terms that cater to the unique needs of new construction projects.
The right financing can provide you with the capital and support needed to make your project a success, and the easiest way to save on a new construction investment is to work with a trusted lender that can get you the best leverage and rates. RCN Capital lends to real estate professionals, commercial contractors, and developers across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors. Contact us today to discuss our new construction financing options.