How Do Construction Loans Work? A Guide to Financing New Builds

If your clients are considering building a property from the ground up, they’re likely wondering, “How do construction loans work?” As a broker, you’re in the perfect position to guide them through the process and help them secure the financing they need to bring their vision to life.

Here, we will break down the entire scenario brokers must understand about how construction loans work, from applying to the necessary requirements and the selection of the right lender. Whether your clients are constructing a single-family residence, a multi-family complex, or a commercial development, this guide will assist you in adding value at every step.

What Is a Construction Loan?

Construction loans are short-term loans meant to pay for building property from the ground up. Different from traditional mortgages, which have a single amount disbursed when issued, construction loans are delivered in phases called "draws" as development unfolds.

Key Features of Construction Loans:

• Short-Term: Typically 12–18 months.
• Higher Interest Rates: Due to the increased risk for lenders.
• Draws: Funds are released in installments as construction milestones are met.

For brokers, understanding construction loans is essential for helping clients navigate the complexities of new builds and secure the financing they need.

How Do Construction Loans Work?

Construction loans work differently than other loans. Here's a step-by-step explanation of how they work:

1. Application and Approval

Your customers will have to submit detailed plans, a construction budget, and evidence of income in order to be considered for a construction loan.

How Brokers Can Help:

• Assist clients in preparing a comprehensive loan application.
• Connect clients with architects and contractors to create detailed plans and budgets.

2. Disbursement of Funds

Funds are paid out in stages, or "draws," once approved, as the work is done.

Typical Draw Schedule:

1. Land Purchase: Covers the cost of acquiring the land.
2. Foundation: Funds for site preparation and foundation work.
3. Framing: Covers the cost of framing the structure.
4. Interior Work: Funds for plumbing, electrical, and interior finishes.
5. Final Draw: Covers final touches and inspections.

How Brokers Can Help:

• Work with clients to create a realistic construction timeline.
• Ensure clients understand the drawing process and what’s required at each stage.

3. Repayment

After the construction is finished, the loan is to be repaid or refinanced into a long-term mortgage.

How Brokers Can Help:

• Help clients explore repayment options, including refinancing or selling the property.
• Partner with lenders like RCN Capital to offer flexible financing solutions.

Key Requirements for Construction Loans

Construction loans have more stringent requirements than regular loans. Here's what your clients must meet to qualify:

1. Good to Excellent Credit

Lenders usually require a credit score of 680 or better for construction loans.

How Brokers Can Help:

• Review clients’ credit reports and address any issues before applying.
• Recommend credit repair services if needed.

2. Sufficient Income

Lenders prefer your clients to have sufficient income to make loan payments while construction is underway.

How Brokers Can Help:

• Help clients gather proof of income, such as pay stubs, tax returns, and bank statements.
• Highlight clients’ financial stability in the loan application.

3. Down Payment

Most construction loans demand a down payment of 20–30%.

How Brokers Can Help:

• Assist clients in saving for a down payment or leveraging existing assets.
• Explore options for using land equity as part of the down payment.

4. Construction Budget

A comprehensive construction budget is necessary to obtain a construction loan.

How Brokers Can Help:

• Work with clients to create a comprehensive budget that includes all costs, from permits to labor.
• Recommend contractors who can provide accurate cost estimates.

5. Low Debt-to-Income Ratio

Lenders want borrowers with a debt-to-income (DTI) ratio of 43% or less.

How Brokers Can Help:

• Help clients reduce existing debt before applying for a loan.
• Highlight clients’ strong financial position in the loan application.

How to Choose the Right Lender

Selecting the appropriate lender is important to obtaining the best terms and a seamless construction process. This is how you can assist your clients in making the best selection:

1. Ask the Right Questions

Encourage your clients to ask potential lenders the following questions:

• What types of construction loans do you offer?
• Are interest rates fixed or variable?
• Can I use land equity as part of my down payment?
• How are construction draws disbursed?

How Brokers Can Help:

• Provide clients with a list of questions to ask lenders.
• Accompany clients to meetings with lenders to ensure all questions are answered.

2. Compare Loan Options

Various lenders have various terms, so comparisons are needed.

How Brokers Can Help:

• Partner with multiple lenders to provide clients with a range of options.
• Highlight the pros and cons of each loan option.

3. Consider Lender Experience

Select a lender that specializes in construction loans and has a proven track record.

How Brokers Can Help:

• Recommend lenders like RCN Capital that specialize in construction financing.
• Share testimonials and case studies from satisfied clients.

Construction loans are a great way to finance new property construction, but they present special challenges. By educating your clients on how construction loans operate, getting them through the application process, and selecting the ideal lender, you can establish yourself as a valued advisor and build your business simultaneously.

Why Brokers Should Partner With RCN Capital

At RCN Capital, we know the special needs of real estate investors—and the brokers that serve them. Here's why brokers prefer to work with us:

• Flexible Programs: From fix-and-flip financing to long-term rental funding, we provide solutions to suit your client's requirements.
• Fast Closings: We can close loans in as few as 10 business days, helping your clients move quickly on opportunities.
• Broker-Friendly: We value our relationships with brokers and offer competitive commissions, fast approvals, and dedicated support.

By partnering with RCN Capital, you can provide your clients with the financing solutions they need to succeed in the competitive world of real estate investing.

Ready to take your brokerage to the next level? Connect with us today to discuss our real estate financing solutions and how we can help you grow your business.