Construction finance is required when contractors and subcontractors require funds to cover the gaps between one construction project to another.
Construction is a great industry to be involved in with the UK construction sector being ranked 3rd for business growth (according to IBIS world) over the past five years.
However, as a business, getting paid on time isn’t always something that happens as regularly as many would hope.
This type of finance is worthwhile to know about to avoid many sleepless nights over not getting paid in time for upcoming construction projects. In this article, you’ll get an understanding of what construction finance is and how you can go about getting that finance for your needs.
What is Construction Finance?
When it comes to construction finance, the funds help bridge the wait for payment whether that’s for work that’s complete or still under some form of construction.
Construction finance is an umbrella term that involves many different kinds of funding that are available within the industry.
Many will often opt to receive this finance as a loan that allows the user to purchase the things they require for the project for completion, from labour to equipment and materials. This type of finance is known as asset finance, and you will typically pay this back over time with interest.
There’s also another area of construction finance called invoice factoring. This is a funding solution that involves a lender, whether that’s a bank or independent company, who will pay a large amount of the invoice’s value upfront.
The finance provider will also be the one chasing your client or clients for the debt itself. Once the entire invoice is settled, that lender will take a fee for providing the initial funds.
Types of construction finance options available
You’ll see already that we’ve already gone briefly into the construction finance options that are available. However, there are many different types of finance to consider before moving forward.
Construction business loans: These come in both secured and insecure loans that suit companies in construction that require funding. This type of finance is useful for those who are looking to get a project off the ground or to get it over the finish line.
Invoice factoring: Invoice factoring is known as construction factoring. It hands over the credit control responsibility to the lender, meaning they collect the payments on your behalf. With 54% of businesses in the UK struggling when it comes to late payments on invoices as a result of COVID-19, this type of finance can be helpful to have.
Invoice discounting: This type of credit control responsibility is one that stays with you and is the most simple form of invoice finance, keeping everything 100% confidential.
Construction equipment finance agreements and leasing: In scenarios where you require equipment, there is funding that can provide the appropriate equipment either through financial agreements or through leasing.
With this finance, you’ll often hire the equipment for the duration of the project or for a certain amount of time so that the lease can be paid off in full. At which point, the equipment becomes something you own fully.
How Can I Get Construction Finance?
To secure finance in the construction industry, you’ll want to apply to a lender, bank, or credit broker. This application will often require eligibility criteria that you’ll need to meet and that can vary from one person to another.
- Step 1: Provide the lender with the required information. Basic information like your business name or the name you trade under. The number of months or years you’ve been around, the average monthly turnover, and what you require in terms of additional finance.
- Step 2: Supply relevant contact details to help discuss your arrangement with the lender. This is usually an address, email address, and phone number.
- Step 3: Read carefully through terms and conditions. You’ll then want to see the quotes available, a process which can sometimes be instant or may take a few hours to a day or two to receive a response.
- Step 4: Once agreed, you’ll see the terms of your loan agreement. Make sure these questions are fully understood and once both parties have signed, the construction finance will be paid into your account typically between 24-48 hours after.
What will I need to apply for a construction loan?
There are several things you’ll need to complete your payment application. These include but are not limited to:
- Credit authorization
- Loan application completed and signed
- Self-employed require tax returns for the last two to three years.
- Verification of any other income from various sources.
- Any rental agreements or real estate contracts in place.
- Current stock, bonds, or retirement statements.
- Bank statements for the last two to three months.
Having everything organised and in place, before you apply for construction finance is going to help speed things along quickly.
How Does Construction Finance Work?
Construction finance is a helpful way of making sure those within the industry are getting the right financial support. With that being said, here’s a more detailed overview of what you can borrow, the loan rates, fees, and repayments, as well as some other commonly asked questions.
How much can I borrow on a construction loan?
The amount you can borrow will often depend on the lender. Some won’t have a cap on how much you borrow but there will be some that have a limit, whether that’s a bank or private lender.
It’s worth doing your research and looking at how much you can borrow as a maximum. You may find that you need more to boost your cash flow or just enough to help push things along in your construction project.
Do you need a deposit for a construction loan?
Typically, you need to have a 20%-40% down payment and this will again depend on the lender. Some will require more and others won’t require as much.
As well as this, you’ll likely need specific building plans to show what you require the construction loans for.
Construction loan rates, fees & repayments
For construction finance providers, you’ll expect the loans to have higher interest rates. For lending interest, it’s charged on the amount you borrow and most of these loans are often interest-only loans. That way, you only repay the interest that you’ve incurred on the loan itself and not the entire loan amount instead.
How long does a construction loan last?
A construction loan is typically a short-term loan that will last around a year to provide enough time for the build to be complete. However, this may be slightly different from one lender to another with some opting to give less time and others, a bit more.
What Can Construction Finance Be Used for?
Construction finance can be a great opportunity to help assist with several issues that can crop up through a lack of cash flow in business finance.
Helps avoid late payments: Late payments can incur late fees but more importantly, they can damage relationships with fellow partners and suppliers. With construction finance, you’ve got the peace of mind you’ll be able to meet your payment deadlines.
Provides a boost to your turnover: Having a boost to your turnover can help put you in a stronger position when it comes to borrowing money. That can directly help with increasing the business’s profitability.
Good payment practice for payroll and suppliers: Talking of late payments, a construction finance solution can help keep good payment practices in place for your payroll and all the suppliers you’ll work with on current projects and future ones.
Improved purchasing power: When you have more cash flow and working capital to work with, it means your purchasing power improves greatly. This doesn’t only benefit your current construction project but any future projects that might at the moment, be out of reach financially.
What Are the Risks Involved with Construction Finance?
There are always risks with borrowing money. When it comes to construction finance, the current output in the UK is over £110 billion per annum. So whilst there may be risks, they are often worth taking.
Contractors overrunning on the project
There can be unexpected delays that can come with construction projects and with delays, it means you’ve got more payments to pay and that the working capital you were hoping to receive from the completion of the project is further out of reach.
Construction costs
Costs in the construction industry can sometimes not be as accurate as you’d hoped, especially when there are delays or you’ve ended up discovering problems within the construction itself.
Does My Business Qualify for Construction Finance?
As long as your eligibility criteria match that of the lender, then your business will likely qualify for construction finance. This all depends on the lender and what they require from you as the borrower.
Typically, you’ll need to have a certain turnover that will dictate how much you can borrow. Some lenders will require you to have been trading as a business/self-employed for X amount of years.
Every lender is different so don’t get disheartened if you find one that you’re not eligible for.
The Pros and Cons of Construction Finance
There are many pros and cons when it comes to construction finance. Here are just a few for you to consider.
Pros:
- Flexible repayment terms
- You only pay the interest on the loan
- Freedom to choose lenders
Cons:
- Minimum eligibility criteria required
- Higher monthly payments
- Costs may be higher than expected
Can I Get Construction Finance If I Have Bad Credit?
Yes, even if you’ve got bad credit, you can still get access to construction finance. However, you may find that more limitations could cause you to struggle when trying to get a good deal.
A recent study done by YouGov found that nearly 40% of adults admit to missing debt payments which leads to poor credit ratings. It’s a useful practice to try and improve your credit score as much as possible and to take control of your payments.
How to Choose a Construction Loan Lender
Choosing the right construction loan lender is important and can be done so by looking at the interest rates and terms that come with each borrowing opportunity. You will quickly find which lenders offer a better deal than others.
Making sure the lender aligns with your financial situation and the policies it has in place regarding the loan are also important.
Who Offers Construction Finance
Many organisations offer construction finance, for example. many banks will lend to the construction industry. You may find it helpful to look on comparison sites to find what’s available on the market and what you can afford.
You’ve also got lots of independent lenders and private lenders that might only be found by going through a broker. It’s good to assess the lending market as a whole before you go ahead with the first business finance opportunity you see.
Final Thoughts
Construction finance is certainly worth making use of where you can. With an extra boost to your cash flow, it puts you in a much better position for all your construction projects ongoing and in the future.
FAQs
Can construction finance be used for builders?
Finance providers can help provide funds required by builders who may need to pay for equipment, materials or additional labour. As long as the borrower checks off all the various legibility criteria, there’s no reason why builders wouldn’t be able to make the most out of construction industry finance providers.
How soon will I receive my construction loan?
Once you’ve qualified for the loan and it’s been approved by the lender, then the lender will begin paying out the money that they agreed to loan out. Whether that’s paying it all up-front or scheduling various payments.
The delivery of the loan will depend on the lender. This could be 24-48 hours to several days.
What impacts my business’ eligibility for construction finance?
Several factors could impact the business’ eligibility for finance. Previous financial agreements that may have ended badly could show on your record. As well as your credit score and how high or low that might be. For those with poor credit scores, you may be limited to which lenders you can borrow from.
What is a construction loan risk management policy?
A construction loan risk management policy helps protect the lenders when giving out construction loans. It relates to the overall management of the loan including identifying the potential risks, measuring those risks, and monitoring them to ensure the client borrowing the loan can successfully pay it back.