Let’s say you want to build a house and sell it for profit. You go to the bank and they reject your application. There are a million and one reasons why they would do so. The obvious ones are bad credit, insufficient income to service the loan and not enough initial capital. They can also reject you based on your lack of experience as a builder. Or they may have a more conservative policy and not allow you to borrow enough.
But regardless, is going to a private lender for a construction loan a good idea? Is this good debt? Well, let’s take a look at the numbers.
Let’s assume you want to build a house in East Vancouver. The lot is $1,000,000. You want to build a 2500 square feet home at $150/sq ft. So this means the construction cost is $375,000.
Let’s assume you can sell the home for a 15% profit. That is 15% times the value of the land and the construction costs ($1,000,000 + $375,000). That is a profit of $206,250 before borrowing costs.
You can get a private construction loan for as low as 7%. The loan is usually for about a year; however, because the loan is dispensed in stages and you are not charged interest until you draw the money, you really do not pay 7% for the full 12 months for the full amount.
Usually the lender will give you up to 75% to buy the land. Then when you are about 40% completed the construction, the lender will provide you the next draw, which is equal to the amount of money needed to take you to 40% completion. This means you have to come up with the first portion of construction cost upfront. The second draw should take you to 70% completion and the third draw will be when the building is complete.
Because of this your total interest payment for the year maybe $63,000. If you go to a conventional lender, you might be able to save a couple of percent, which is about a savings of $18,000. The private lenders have a lender’s fee which maybe 2 more than your convention lenders. In this case, you are also spending at extra $24,000 in lender’s fees.
So is it worthwhile? Well, it is quite simple. Even though you spend $42,000 more, you are still making a profit of ($206,250 – $63,000-24,000) $119,578. The other option is to wait a year or two to improve your financial position, but you would be able to build two more houses in that time and make another $240,000. It is clear in this case that private lending is the more profitable way to go. Also with private lenders, the process is easier, faster, and often you can get more momey and more flexible draws.
This serves as a general example. Every case is different. Each lender have their variations in business practices. And rules and regulations as well as rates do change. If you are interested, please contact us for up-to-date information and a free consultation.
