Construction projects often operate under set timelines and require specific kinds of funding to be completed. You need to understand how construction loans work if you are going to be able to start and complete a construction project in a timely and effective manner. There are some things that all construction companies should understand before they apply for these kinds of loans both to prevent confusion and to improve timeliness.
LTC vs LTV is a key factor in construction project lending. You might never have thought about what these two terms mean since you simply applied for loans and then got back to planning the jobs that you were working on. You do need to know the difference between LTC and LTV when you apply for any kind of construction loan, since these loan types impact the way that you proceed with projects.
What is a Construction Loan?
The first thing we need to define is what a construction loan actually is. You probably know it’s the loan that you get to build a residential building. This kind of loan is given to “stick-built” projects and doesn’t get used for other kinds of construction.
Construction loans will cover costs associated with the land and the lot, the labor that is necessary for the job, building materials, and permitting. Design costs are not included, which can be a common misconception, and costs for designers for the interior of the building are also not included.
Your construction loan will provide lump sums to you for use during the project. These “draws” are what fund your project throughout its stages. You need to be careful to be on target with your project’s timelines so that your draws can be distributed to you. Issues with your project can delay draws and lead to the project running beyond the set projected timelines.
To get a construction loan, you need to be financially stable and be able to make a down payment as security on the loan.
How Do LTC and LTV Impact Your Loan?
Now that we have defined what your construction loan is and what it does, let’s talk about LTC and LTV. These are the two kinds of loans that banks hand out for construction projects. You might think that you don’t need to know which kind of loan you were offered since you just need the draws to do your work.
You do need to understand which kind of loan you were offered, however, because you might find that your loan is capped in a way that you didn’t expect.
Loan to Cost, or LTC loans, are calculated using the project’s total cost. The land, the build itself, and the fees are all financed by your lender. A Loan to Value, or LTV loan, will be based on the appraised value of your building project.
The bank will not let you choose one kind of loan over the other. They will select the kind of loan that makes sense for their risk tolerance and their capacity to handle the loan that they need.
You will need to be able to understand what kind of loan you are being offered when you get the communication about your loan. If you cannot fund your project with one of the two loans without running into issues, you need to be aware of what the two terms mean so that you can try working with a lender who will offer you a more favorable lending opportunity.
Many companies agree to loans each year that they don’t fully understand, just so they can get started on a build that is already set to run behind schedule. You shouldn’t rush through the lending process, and you need to be aware of the way that construction loans function so that you aren’t caught by surprise down the road.
How Does Loan Type Impact Your Project?
These two loan types impact your project in a variety of ways. Large projects tend to be capped at an LTC of 70 to 80%. This means that you will need to have the rest as a down payment you provide to secure the loan. In the case of an LTV loan, the cap might be 60 to 75%. This means that you need to have the remainder of the capital in your own bank account to secure the loan.
Both loan types can work, but some projects will not pair as well with one loan type or the other. You need to be aware of your capital position before you agree to a down payment that will stretch your budget too far.
As with any kind of loan, you can improve your chances of getting a favorable loan offer by making sure that your credit is good and by working with a qualified and experienced appraiser to set the value of your project. Be sure that you have all the necessary documentation needed to support the value of your property and to explain the timeline of the project. These details can make a big impact on the risk that the bank is willing to undertake in order to offer you a loan.
Being an Educated Consumer is Always Wise
You don’t need to know everything about banking when you are applying for construction loans, but you do need to make sure that you are educated about the basics of these kinds of loans. It can be easy to agree to a loan that is not favorable for your job type because you didn’t understand how these loans work. Always make sure to ask questions if you are not clear about what is being offered to you and work with a skilled appraiser to make sure that all of your documentation for the value of the project is correct.
Taking the time to be prepared to seek and bind loans with a lender can help ensure that you get the perfect loan for the project that you have planned.
