Before applying for construction financing, you need a construction financing budget that clearly lays out the amount of capital you require and when its going to be required during the construction period.
This starts with making sure you have all your costs either committed to through contract or invoice, or signed off through quote or estimate from all suppliers of good or services.
And because there can always be things that go wrong or changes can be made to the plan during construction, you should also allow a reasonable amount of capital for contingencies.
Once you have a clear picture of the total amount of construction financing that is required, then the next step is going to determine how much of the total costs will need to be funded out of equity and how much can be debt financed through a construction lender.
In some cases, it may be wise to allow for either equity or a secondary form of financing to be available for all or part of the contingency funds. This is so that if there are any tie ups with getting funds advanced from the main construction loan that you will still have an alternative source of funds available to keep the project going.
When you have developed one or more construction debt funding options, its going to be important to look at a number of things in the funding proposal or commitment.
In particular, you need to make sure exactly what the construction loan will and will not cover off in terms of expenditures, how and when funds can be disbursed, and debt servicing requirements of the construction loan during the time you are utilizing it.
With respect to expenditures covered, don’t automatically assume that all potential outlays that you may have to make on the project are covered by the construction loan. For instance, there are some construction lenders that will not advance funds to pay the GST or HST on a project and require you to cover off those amounts from other sources. If this is not understood at the outset, you can run into a real cash flow crunch when it comes time to pay your suppliers and vendors.
Knowing how the construction mortgage draws are going to be advanced is also important so that you can match up the costs incurred to the draw schedule at the start of the project in order to make sure that each cost to be incurred is properly matched up to the proper draw.
In terms of debt servicing, you’re also going to want to know what you’re going to have to pay monthly in terms of principal and interest payments. This can vary considerably from not having to pay debt servicing at all as its prepaid in the loan, to having to pay interest on 100% of the funding commitment, regardless of whether you are using all the money at one time or not.
By having a clear construction financing budget in place before signing a construction loan commitment, you’re greatly reducing the chances of having cash flow problems during your project.