What Are the Potential Drawbacks of Development Finance?
For all its selling points, and there are plenty of them, development finance is not without its drawbacks.
Development finance is a specialist funding solution for property development and construction projects, which can be arranged at comparatively short-notice. A strictly short-term facility, monthly interest payable on a development finance loan can start from as little as 0.4% per month.
All of which adds up to a flexible and cost-effective form of funding on paper, which it is - for the right applicants with the right applications in mind.
But as is the case with all financial products, there are downsides to consider before applying for development finance.
Key examples of which include the following:
Eligibility Criteria
Development finance is usually restricted exclusively to experienced property developers with an established track record. It is practically impossible to qualify for competitive development finance as a first-time developer, or as a newcomer to the construction sector.
Lenders typically expect to see robust evidence of the successful completion of projects similar to those the applicant is looking to finance this time around. Alternatives to development finance for first-time developers include bridging finance, commercial mortgages and secured bridging loans.
Unsuitable for Long-Term Borrowing
Under no circumstances should development finance be taken out with long-term repayment in mind. Repaid within a few months, development finance can be a hugely affordable facility; longer-term, monthly interest as low as 0.4% can add up to a less than competitive APR.
It is therefore essential to have a concrete exit strategy in place, prior to applying for development finance. Clear evidence of a viable exit strategy is also a prerequisite for qualification for development finance.
Lender Involvement
With development finance, the funds are released by the lender in a series of stages as the project progresses. Completion of specified phases of the project results in the release of the next instalment, only when the lender is satisfied that the project is progressing as planned.
This is the kind of involvement some property developers would prefer to forgo. With products like bridging finance, for example, the full loan amount is released in one lump sum at the start of the project.
Collateral
Development finance is a type of secured borrowing, which inherently involves the provision of collateral as security. This will usually take the form of the development itself, or other assets of value - like residential or commercial properties.
Borrowers therefore run the risk of having their assets repossessed and sold by the lender, if they are unable to repay their debts as agreed; though this is also true for all other forms of secured borrowing, where assets are used as collateral.
Restricted LTV (Sometimes)
Most development finance specialists restrict their products to around 70% or 80% of the project’s total value. This subsequently means that the remaining 30% or 20% needs to be covered by the developer, or sourced from elsewhere.
However, some specialist lenders offer bespoke products that combine development finance with secondary loans, in order to cover up to 100% of the project’s costs. This can be a simpler and more affordable option than taking out loans with multiple providers, and is best arranged with the help and support of an experienced broker.
