Development finance is a little more complex than a conventional mortgage, with funds that are issued in a series of stages. The lender appoints a surveyor to monitor the progress of the project, tying each loan instalment to the completion of key project phases.
First-charge (aka senior) development finance can be used to cover up to 85% of a project’s total costs. The rest can be covered with a second- or third-charge (mezzanine) product, enabling investors to cover up to 100% of a project’s costs with development finance.
Interest on a development finance loan accrues monthly, often at a rate of around 0.5% or less. But what are the total borrowing costs payable on development finance, and how are interest payments made?
How much does development finance cost?
Various factors influence the costs of development finance loans, including but not limited to the following:
- The track record and CV of the applicant.
- The nature and extent of the planned project.
- The location and value of the development.
- The sum of the loan required and its LTV.
- The projected final value of the development.
- The length of the loan repayment term.
As a general rule of thumb, development finance loans of £500,000 or more will typically have an interest rate of around 4% to 9% per year. Loans with a value of less than £500,000 are more likely to be charged at 9% to 12% per year.
However, interest rates are always negotiable, based on the factors above.
Additional borrowing costs incurred as part of a typical development finance product include the following:
- Lender arrangement fee: normally around 1-2% of the loan amount
- Lender exit fee: not always payable, but can be up to 1-2% of the loan amount.
- Valuation and monitoring of surveyor fees are variable by way of provider.
- Broker fees: brokers collect their commissions from the loan issuer and offer their services free of charge to the applicant.
Across the board, all borrowing costs can be minimised by enlisting the support of an experienced broker at an early stage.
How is the interest on a development finance loan paid?
Most development finance specialists are fairly flexible when it comes to interest payments.
There will usually be the option of repaying the interest on a monthly basis, leaving just the initial loan balance to repay when the facility matures. However, property developers often prefer the ‘rolled up’ interest option, where all interest owed is added to the final loan balance.
With the latter option, no monthly repayments at all need to be made during the life of the loan. This often suits the requirements and priorities of property developers looking to keep their own capital as liquid as possible.
Either way, prompt repayment holds the key to minimising the costs of development finance. Early repayment may be an option, but depending on the lender’s policies, it may result in early exit fees becoming payable.