Construction financing cash flow management starts with a well detailed construction budget and spending time line that accurately identifies when every type of expense will be incurred and where the funds will be paid from. This is an area where many projects break down and fall apart, even after being approved for a construction loan.
Here are some of the more common items to consider before even starting your project.
First, make sure you clearly know what expenditures will be covered by the construction loan and what items will not. Its not uncommon for construction mortgage not to cover HST which means you’re going to have to have another source of funds to cover these costs. Depending on the lender, the hold back may be larger than what is required by law, so don’t automatically assume they will be the same.
Second, with private mortgage construction loans, the lender may require you to be servicing the entire approved financing amount from day one, and not just the amount that is drawn at any given time. This can place a dent in your cash flow if you haven’t allowed for the added cost.
Third, get totally clear as to what is going to need to be completed and invested via equity in the project prior to the issuance of the first draw. The first construction draw is arguably the hardest to get as until the initial funds are advanced, the lender has not invested in the project so they may be quite particular as to assessed state of completion before any monies get advanced. To this end, its not only going to be important to clearly understand what needs to be done to get to the first draw, but its likely going to be wish to have some amount of contingency available if there is any discrepancy between the work you have completed and the appraisers assessment.
Fourth, make sure you have some source of contingency funds available throughout the project. While there is no hard rule for contingency allowances, many builder will work with an 8% to 10% buffer.
Outside of the actual construction, the hardest aspect of a construction project is understanding the timing of expenses and matching sources of funds to different uses. The better this is outlined from the outset, the less problems should occur with respect to cash flow during the life of the project.
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