Are you interested in knowing the difference between the big banks and private funding for property development? If so, you’re in the right place.
But unless you’ve got enough working capital to fund a project yourself, you’ll need it financed.
And property development finance is a whole different kettle of fish when compared to a standard home loan. It even differs from a standard investment loan to purchase existing property to rent out.
This helpful article will explain the difference between borrowing money from the big banks and a private lender.
But first, let’s explain in more detail about residential development finance.
Property Development Finance – More Information
As mentioned before, property development finance differs from a home loan or investment loan.
This type of finance is aimed at funding the building of several properties on one block of land. This lot is then subdivided, and each property sold on its own separate title.
If you build two, three or even four units, you will apply for a residential property development loan. But if you want to construct five or more properties, you’ll need a commercial loan.
And the differences between these two types of loans are vast.
For argument’s sake, we’re going to assume you are seeking a residential property development loan.
If you are based in Melbourne, check out this ultimate guide to property development loans.
The Big Banks
You know these banks. You probably have an account or two with them. The big four (the three above and Wespac) banks in Australia account for billions of dollars. They hold money from regular citizens to big business and high net worth individuals.
Obtaining a loan for development from a big bank is similar to any other sort of finance, but with a few differences.
In most cases, you can borrow up to 80% of the total expenses of the project. Note that this is only for the construction, labour and materials. In addition, you will need to fund surveying, the design, any marketing and sales and other costs yourself.
This means having some working capital as well as applying for a loan.
Loan to Value Ratio
Now you need to consider the loan to value ratio or LVR. This is the difference between your deposit and your loan. For instance, for a $3 million project, you will need a $600 000 deposit.
You may be able to use the equity in an existing property to unlock the deposit.
Higher Interest Rates
Also, a development loan will see a higher interest rate than an owner-occupied home loan or even an investment loan. Expect around 1-2% on top of the rates for these loans.
Have a Buffer
Now, it is best practice to have some liquid cash ready as a buffer. Things can and do go wrong on development projects all the time, so having some financial wriggle room is a must.
The Downsides of Big Banks
There are some negatives about using a big bank.
The first is these days, and it is harder to get approved for finance. This is due to the fallout of the banking royal commission.
Banks will usually require some evidence of off-the-plan sales before they will loan you money. They are also lending less and need you to have more money upfront.
Banks are Still an Option
The above said, banks are still an option. You just need to be prepared to go through the process and provide everything they need.
Now let’s talk about private lenders.
What is a Private Lender?
A private lender is a lender that is not a bank.
These are usually companies that manage trust funds, hedge funds or other pools of money.
Some private lenders specialise in development finance.
The Advantages of a Private Lender
If you struggle to get your project financed at a bank, a private lender may offer you the finance.
- This means that you can still make a development project happen.
- They may be able to offer a more competitive interest rate or may not. We’ll cover this below.
- Also, they can be an option if you have a mark on your credit file.
- Compared to a big bank, you’ll get a more personalised and friendly service.
Disadvantages of Private Lenders
Here are some disadvantages of private lenders:
- They may have higher interest rates.
- In addition to this, they may have more fees.
- Also, they may have hidden fees in the small print.
- If their capital is tied up in the stock market, there is a risk of the company dissolving if a crash occurs.
What’s Right for Me? And Conclusions
Like any personal financial decision, you need to make an informed choice. So do some research and consider engaging a qualified professional. A good financial advisor is worth their weight in gold.
Weigh up your options and pick the best choice for you.
By now, we’ve fully informed you of the difference between the big banks and private lenders. We’ve weighed up the pros and cons of each so that you can make an informed decision.