Development finance provides experienced property developers and construction businesses capital to undertake projects without tying up their own financial resources. It is a specialist short-term solution for property development and construction projects, typically issued over the course of 6 to 18 months.
But how exactly does a development finance loan works in practice? What are the main differences between development finance and bridging loans, if any?
How Does a Development Finance Loan Work?
Development finance works in a similar way to bridging finance, though with a few key differences.
For example, it is often possible to organise development finance to cover 100% of all project costs. This typically involves combining a first-charge development loan with a second-charge mezzanine finance product, which may or may not be possible with the same lender.
If the borrower’s application is accepted, the funds requested can be authorised within a few working days. However, the biggest difference between development finance and bridging finance is the way the funds are allocated.
With development finance, funding is provided by the lender over a series of instalments. Each subsequent instalment is tied to the completion of a specific project phase, watched over by a professional surveyor hired by the bank.
Interest accrues on a monthly basis (often as low as 0.5%) and is usually rolled up into the final loan balance. Development finance is then repaid in the form of a single lump sum payment, typically upon the sale of the property or development.
Repayment can also take place by switching development finance to a longer-term repayment product, such as a commercial buy-to-let mortgage.
Who Can Qualify for Development Finance?
This is another area in which development finance differs from bridging finance. Bridging loans are open to anyone with assets of value to cover the costs of the loan and a viable exit strategy. By contrast, development finance is issued exclusively to experienced developers and construction companies, with an established and provable track record.
Qualification criteria for development finance in general are stricter and more extensive. Terms and conditions vary from one lender to the next, but the following evidence and documentation will need to be provided as a bare minimum:
- The current value of the property
- The predicted end value of the property upon completion
- A copy of obtained planning permission documents
- The development time schedule
- A portfolio or CV of relevant experience
- Full breakdown of building and renovation costs
- Details of any other contributors and contractors involved
- Any planning restrictions that might apply
- Details of building regulations
Lenders also expect to see evidence of a workable and reliable exit strategy, such as an advance agreement with a qualified buyer for the development.
What Kinds of Fees and Charges Apply with Development Finance?
All development finance products are bespoke agreements between the lender and the borrower. Costs therefore vary significantly from one facility and lender to the next and should be considered carefully before applying.
Development finance interest rates can be as low as 3.95% APR, but a low rate of interest can sometimes be augmented by elevated fees and charges.
Some of the charges you may encounter include administration fees, arrangement fees, brokerage fees, completion fees and so on – potentially adding up to around 2% to 4% of the total value of the loan. Though with some lenders, some (or all) of these fees do not apply, and there are no penalties for early repayment.
Always request a full and clear disclosure of the total costs of the facility from your lender, inclusive of interest and all other fees. Avoid the temptation to focus disproportionately on interest rates, and overlook other key costs in doing so.
