Understanding the Difference Between Development Loans and Building Loans

Understanding the Difference Between Development Loans and Building Loans

When navigating the landscape of property financing, it’s essential to understand the various loan types available. For those in the construction industry or planning to build their own homes, two primary types of financing stand out: development loans and building loans.

While both play crucial roles in the property market, they cater to different audiences and have unique features.

What are Development Loans?

Development loans are a specialised form of financing designed for property developers who are looking to undertake significant construction projects. These could range from building residential estates and apartment complexes to subdividing land for multiple housing units, to commercial developments including industrial complexes and service stations.

Additional reading: What is a property development loan?

Characteristics of Property Development Loans

Purpose

Development loans are intended for large-scale projects. Developers use these funds to cover costs such as land acquisition, construction, and infrastructure development.

Loan Structure

These loans are typically structured in stages, aligned with the progress of the project. Funds are released in tranches as specific milestones are met, reducing the risk for both the lender and borrower.

In a residential development loan, the funds are released in stages as construction progresses. Each of these stages corresponds to significant milestones in the building process. Here’s a breakdown of the individual stages of the loan:

  1. Deposit: This initial payment is made to the builder before construction begins. It typically represents a percentage of the total contract cost and is necessary to secure the builder's services. The lending institution will release funds to cover this deposit once it has been requested.

  2. Footings/Foundations: This stage involves the excavation and laying of the foundation for the property. Once the foundation is completed and inspected, the lender will release the next portion of funds to pay the builder for this work.

  3. Framing: In this stage, the structural framework of the building is erected. It includes the walls, roof, and floor framing. Upon completion of the framing and following any required inspections, the lender will provide the next installment of funds.

  4. Lock-up: At this point, the building is “locked up,” meaning that the external walls, windows, and doors are installed. This stage ensures that the structure is secure and weatherproof. Once the lock-up stage is completed and inspected, the lender will release the funds allocated for this stage.

  5. Fit Out: This stage includes all internal work, such as installing insulation, plastering, cabinetry, plumbing, and electrical work. Once the fit-out is finalized and inspected, the lender will provide the corresponding funds to pay for these completed tasks.

  6. Handover: The final stage of the loan process occurs when the construction is complete, and the property is handed over to the owner. This stage may involve a final inspection to ensure everything meets the required standards. Once completed, any remaining balance of the loan will be released to cover any outstanding costs.

Throughout the construction process, lenders often require inspections at the completion of these stages to ensure that the funds are being used appropriately and that the project is on track. This staged funding approach helps to mitigate risks for both the borrower and the lender, ensuring accountability in the use of the loan funds.

Loan Amount

Given the scale of development projects, the loan amounts are usually substantial, often running into millions of dollars. This requires thorough due diligence from both the lender and the borrower.

Assured Management focuses on construction and development loans between $1 and 12 million.

Interest Rates

Development loans generally carry higher interest rates compared to standard home loans due to the increased risk involved. However, the interest may be capitalised during the construction period, with repayment commencing once the project generates revenue.

The interest rate is typically influenced by the strength of the development plan and the developer's track record on previous projects.

Risk Assessment

Lenders conduct detailed risk assessments before approving development loans. This includes evaluating the developer's experience, project feasibility, market conditions, and the potential for revenue generation.

There is a higher risk in funding property developments due to inherent uncertainties in the development process. Factors such as construction delays, cost overruns and market fluctuations can impact on the profitability of the project. Despite this, property developments can yield high returns.

Learn more about the risks in property management and tips on how to manage these risks. 

Loan Term

The tenure of development loans is usually short to medium-term, typically ranging from 12 months to 5 years, depending on the project size and scope. Be prepared to discuss your project timeline, financing requirements, and preferred repayment terms with potential lenders.

Key Considerations When Applying for a Development Loan

Project Feasibility

Lenders will carefully evaluate the feasibility of your development project, including factors such as market demand, construction costs, and potential returns.

Financial Strength

Your financial strength, including your credit history, business experience, and personal net worth, will be a key consideration for lenders.

Collateral

Development loans are typically secured by the property being developed. Lenders may require additional collateral, such as personal guarantees or assets, to mitigate risk.

What are Builder Loans?

Builder loans, on the other hand, are designed for individuals or families who intend to build their own homes. These loans are tailored to meet the needs of owner-occupiers rather than large-scale developers.

Characteristics of Building Loans

Purpose

Builder loans are for financing the construction of a single dwelling, typically the borrower's future home. This can include building a home from scratch or conducting extensive renovations.

Loan Structure

Similar to development loans, builder loans are also often disbursed in stages of construction, with funds released as the build progresses. This ensures that the loan amount is used specifically for building purposes.

Once the building stage is finalised, the construction loan will revert to a typical mortgage with monthly principal and interest repayments.

Loan Amount

The loan amount for builder loans is usually smaller compared to development loans. It is generally based on the estimated cost of building the home, including labour and materials.

Interest Rates

Builder loans usually come with interest rates comparable to standard home loans. However, some lenders may offer variable rates during the construction phase, with the option to switch to a fixed rate once construction is complete.

Repayment Terms

Repayments on builder loans typically begin immediately after each stage's funds are disbursed. However, during construction, borrowers may only need to pay interest on the loaned amount, with full loan repayments starting after the home is completed.

Loan Tenure

Builder loans usually have a longer loan term, often aligned with standard home loan terms, which can range from 20 to 30 years, depending on the lender's policies.

Is a building loan the same as a construction loan?

Yes, a building loan is essentially the same as a construction loan. Both terms refer to a type of home loan specifically designed for borrowers who are building or renovating a property, rather than purchasing an existing home. These loans allow for progressive drawdowns or progress payments, which means that funds are released in stages as construction progresses, rather than in a lump sum. This structure helps manage cash flow during the building process and can provide flexibility and potential savings in interest costs.

Key Differences Between Development Loans and Builder Loans

Target Audience

  • Development Loans: Intended for professional property developers.
  • Builder Loans: Geared towards individual homebuilders or owner-occupiers.

Scale of Financing

  • Development Loans: Larger amounts, often in millions, to fund large-scale projects.
  • Builder Loans: Smaller amounts, sufficient to cover the cost of building a single home.

Risk and Due Diligence

  • Development Loans: Involves a higher level of risk, with extensive due diligence required.
  • Builder Loans: Generally lower risk, with a more straightforward approval process.

Interest Rates and Repayment

  • Development Loans: Higher interest rates with repayments typically beginning post-construction.
  • Builder Loans: Competitive interest rates with repayment starting during or after construction.

Loan Terms

  • Development Loans: Short to medium-term, matching the project timeline.
  • Builder Loans: Longer tenure, aligned with traditional mortgage terms.

How to Apply for Property Development Finance

The application process for commercial or residential property development finance involves a few key steps, similar to any other type of loan. The process begins with ensuring you meet the lending criteria, then completing a loan application form or submitting a detailed project proposal. Lenders typically require the following (though this may vary from lender to lender):

  • A Fixed-Price Construction Contract
  • A Project Feasibility Study
  • Relevant Development Approvals (DA): Ideally, this includes Building Approvals (BA), Operational Works approvals, or a construction certificate.
  • Borrower Information: This includes a statement of assets and liabilities, and financial statements.
  • Proof of Experience: Demonstrating the borrower’s background and track record in construction and development is crucial.

When seeking developer finance, transparency is key during negotiations with a financier. Since thorough due diligence is a standard part of the loan assessment, any undisclosed information could lead to complications later on. Being upfront helps ensure that the loan process proceeds smoothly. Here's more information about how to get property development finance.

About Assured Management

Assured Management (AML) is a flexible, non-bank lender with the ability and expertise to work directly with property developers to complete projects in a timely and profitable manner. 

We provide tailored construction finance solutions for developers looking to build:

To apply for a residential or commercial property development loan please contact AML and speak directly to the loans approval team by phoning (07) 5578 6177. You can also send through your enquiry online.