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How do construction loans work?

What is a construction loan?

A construction loan is a short-term loan, often for a term of one year, taken out to pay for the costs of ground-up development or renovations. There are a few different types of construction loans including construction only, construction to permanent (i.e. building costs and long-term mortgage combined) and renovation loans. Construction financing covers the cost of work and materials including labor, permits, interior and exterior framing and finishing. It includes anything permanent, therefore it may include outdoor plantings or a solid kitchen island. It does not include patio or internal furniture or anything considered removable. Rather than a lump sum, you will receive regular payouts of this loan. With some loans you may receive money according to a schedule, for others, you may have to submit invoices for reimbursement. Ask your lender for details.

Construction financing in New York City is seen by some lenders as potentially risky and therefore may come with a higher price tag. The reason for the higher interest rates associated with construction loans is that with a typical mortgage the building itself is put up as collateral. If the borrower is unable to pay the mortgage, the lender lays claim to the building and can re-sell it. In the case of a construction loan, there may be no building, or in some circumstances, the property is simply unlivable, and there is no collateral if the loan defaults. By the end of the loan’s term, the home must be able to become occupied or obtain a certificate of occupancy. 

The good news is that construction loans are short term, so your interest costs will be minimal anyway. If a new build, major home renovations or condo development are what you’re looking for, a construction loan may be a good option. 

How construction loans work in multi-family developments.

Loans are available for most types of residential and commercial construction. A construction loan does not provide a lump sum check. Instead, the lender pays the constructions costs over time as the work is completed, and the interest accrues only on the amount that has already been disbursed. 

Here’s an example of how construction financing works. You, the borrower, would be required to submit a downpayment. Let’s say you’re buying a property for $500,00. You put down $100,000, or 20% of the purchase price. Based on your renovation plans, your property could be appraised at $2 million. The lender will usually loan up to 75% or 80% of the appraised value of the property after the renovation is complete, so in this case, you can get a loan up to $1.5 million. The true amount of the loan will depend on the estimates for the cost of construction. The lender will require a clear construction plan with a detailed cost breakdown. You may need to provide actual cost estimates from contractors or the lenders may consider a detailed plan of your own to be acceptable. 

construction loans in new york city

How construction loans can help the development process.

To be approved for a construction loan in New York City you’ll need to provide a timetable, renovation or construction plans, and a budget. This may feel like a waste of time, but planning these details ahead of time will ensure that your project is successful and profitable. That’s only one of the ways that construction financing may benefit you. 

It’s important to understand how construction loans are helpful in the development process. Construction financing enables you to invest minimal capital in the purchase and renovation of a potentially high-value project. You can buy the property for less than it’s worth and finance the construction costs for getting it move-in ready. 

Another benefit of construction loans is the way they are structured to pay out on a schedule and be paid back relatively quickly. Using a loan for a very short-time helps keep the costs of financing low. Since the borrower is only accruing interest on the money that’s been paid out to date, money is saved there as well. Once construction is complete, your property should have increased significantly in value, allowing you to sell or refinance. In either situation, you should be able to make a profit from this deal, taking out the cash that you’ve generated and put it into your next multi-family development. Construction loans are designed for you to refinance a property after purchasing, giving you the ability to buy low and sell high, or rehab, refinance and collect higher rents for years to come. 

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