Differences Between Development Finance and Construction Loans

Differences Between Development Finance and Construction Loans

Both development finance and construction loans are applied for and granted to fund commercial and residential building projects. They are also similar in the sense that they are both specialist types of bridging loans, issued against the property being built, renovated, improved or repurchased.

Understanding the differences between development finance and construction loans can make it easier to select an appropriate source of funds for your project.

What Is a Construction Loan?

Construction loans – sometimes referred to as a self-build loans – are short-term financial products to fund the construction of residential and commercial properties. The applicant takes out a loan to cover the total construction costs, which must typically be repaid after no more than one year.

A construction loan is somewhat similar to a bridging loan, in that the balance must be repaid within a short period of time. They can also attach comparatively high rates of interest and borrowing costs, as they are considered relatively risky financial products.

How a Construction Loan Works

Where an application for a construction loan is accepted, the money is made available within a relatively short period of time. The applicant will have provided evidence of a viable exit strategy – any means by which they intend to repay the balance at the end of the term. If the borrower cannot (or chooses not to) settle the loan with a lump sum payment, they could choose to refinance the construction loan using a longer-term mortgage product.

Construction loans are relatively flexible in terms of the sums of money available, so it is not necessary to apply for more than you need. There may also be the option of repaying the loan early without facing excessive penalties (individual lender policies apply).

What is Development Finance?

The biggest difference with development finance is the way in which it is designed for more extensive construction and development projects.  Development finance is the preferred option where millions of pounds need to be borrowed to fund large-scale residential and commercial builds.

Development finance is usually only made available to experienced property developers and builders with a proven track record. It is therefore not a viable option for the construction or improvement of a single home or a smaller commercial property.

How does Development Finance Work?

Loans are issued on the basis of the projected future value of the project as a whole. After a formal valuation and careful consideration of the applicant’s status, the first instalment of the money is released to get the project underway.  After which, additional funds are released gradually as each new phase of the project begins.

At regular intervals, the lender will conduct formal inspections and assessments to ensure the project is progressing as predicted. Development finance is repaid either as a lump sum payment at a later date, or when the project is refinanced using a longer-term product.

Speak to an independent broker for more information on the difference between development finance and construction loans.