One of the more direct impacts on investment returns is the underlying financing. Residential construction loan rates are variable, so it's essential to recognize what factors may impact your rate to secure the highest profitability for your project.
Larger market trends impact all interest rates, but their influence on variable-rate financing is much more profound. Residential construction financing rates aren’t fixed and are higher than a traditional mortgage because there’s increased risk when an asset isn’t yet completed. As rates rise and fall throughout construction, your payments and profits will do the same.
Factors Affecting Home Construction Loan Rates
While both conventional and construction loans are secured by real estate, understanding residential loan interest rates comes down to finished and unfinished collateral.
Additional factors that affect loan rates are:
- Borrower’s credit: Lenders rely on credit scores to evaluate the potential for someone to default on repayment, and it informs loan rates as a factor of risk.
- Economic conditions: Inflation and interest rates often move in the same direction. As inflation rises, so will mortgage and residential construction loan rates, home prices, and the cost of construction materials and labor. Variable interest rates are tied to an index, such as the federal funds rate. As the index rate fluctuates, so will the loan’s interest rate and interest-based payments.
- Supply and demand: As the Federal Reserve moves rates with banks in response to economic conditions, private lending rates move according to the supply and demand of private capital.
Impacts of Variable Interest on Residential Construction Loans
Residential real estate construction comes with risk, but it’s not without reward. Being aware of how variable interest rates can have positive and negative impacts on construction loan rates will allow you to leverage the market conditions to your advantage.
Positive Impacts
Favorable government policies can stimulate the construction industry and reduce rates for building loans. Strong economic conditions also promote a low-interest-rate environment and reduce inflationary pressure on materials. When rates are low, they reduce interest-based payments and increase profitability for an investment property requiring construction.
Negative Impacts
Variable rates are difficult to budget for because the payment changes and economic instability can drive rates higher. When rates are high, the cost of ownership increases and impacts potential profits.
As inflation increases, the cost of materials and labor will not only increase the size of the loan required, but it will also impact how far funds stretch as the loan is distributed. This may disincentivize lenders from issuing residential construction loans or result in higher rates. Borrowers can proactively contribute to a larger down payment to reduce the risk the lender assumes.
How to Secure the Best Construction Loan Rates
Prepare your application before you shop around so you can begin construction while conditions are favorable. Each lender’s requirements will vary, but it’s safe to assume you’ll need:
- Good financial standing, influenced by your credit score and debt-to-income ratio: Many lenders will have requirements for both, so be sure to review your finances in advance for awareness of your eligibility.
- Cash for down payment: The general rule for residential construction loans is that the buyer needs a 20 percent down payment. Alternatively, some lenders may require the borrower to own the land outright.
- Construction plans: Include detailed building plans and blueprints, a budget of materials and labor with a corresponding payment schedule, and a signed contract from a builder. It’s always worthwhile to account for hidden costs where you can.
- Contracted trade partners: Work with one you trust, or vet new construction partners for reliability to prevent delays. Your builder should also be in a financial position to carry out the project. They will need dry powder to keep the project moving along before construction funding draws are available.
- Track record of past projects: Provide a resume of any previous residential construction projects with photos and numbers to demonstrate your history of successful outcomes. This will go a long way to support your application and secure better pricing.
Once you’ve prepared your application:
- Determine the type of construction loan you need. Whether construction-only, construction-to-permanent, or residential rehab, you have plenty of options to fit your project.
- Compare lenders and terms for the most competitive offer that aligns with your eligibility. This will have a significant impact on your investment returns. Submit multiple applications to place yourself in a position to negotiate. Look for:
- Lower rates
- Flexible down payment requirements
- Flexible credit score requirements
- Construction draw process
- Consider preapproval to expedite your application before a prospective property slips away.
Construct Your Next Project with Herzer
Many factors impact residential construction loan rates, but there are still plenty of ways to make them balance in your favor. As quickly as opportunities appear in real estate, being prepared to secure funds quickly can be as beneficial as timing for the most favorable market conditions.
If you’re looking for a reliable private lender for your next residential construction project, consider Herzer for fast, hassle-free financing. Contact the Herzer team today.
