People always get hung up on interest rates, but when it comes to the cost of development finance, they’re only part of the equation.
It’s often all the other rates, fees and hidden costs, which—if you’re not careful—add up, eating into your profits and potentially costing you other opportunities.
Here are some essential things to consider when trying to understand (and minimise) the total cost of your loan.
How do bank and non-bank lenders compare?
Banks charge lower interest rates and fees (so they seem cheaper at first), but there are hidden costs behind those headline numbers.
For starters, banks are much more conservative—usually only willing to lend up to an LVR of 60-65% and an LTC of between 75-80%. That means having to front with more equity, and equity is expensive. If accessing the extra cash means embarking on a joint venture, for example, that’s half your profits gone.
Then there’s the added bureaucracy. Banks require more presales, their QCs are more expensive, and they’ll typically want a bond from your builder.
Non-banks, by contrast, are generally much more flexible. In some circumstances, non-banks may be willing to lend up to an LVR of 80% and up to 90% of development costs, meaning you’ve got less money tied up. In return, you’ll pay a premium in rates and fees. Most non-bank lenders set their pricing to achieve an overall return of 15%-18%.
What else do I need to watch out for?
Development finance has three main costs: the interest rate, establishment fees and line fees. And it’s that last one that can really sting you.
The line fee is a rate charged monthly on the total limit of the loan and over the loan term. So, it stays the same no matter how much or little you’ve drawn down. Typically, line fees range from 1.3% to 1.8% p.a. (or 0.1% to 0.15% per month), but the most expensive I’ve seen is 3.0% p.a.
When the establishment fee and line fee are added together, they can be as high as 6.00% of your total borrowing. Development loans progressively draw down. If applied to an average drawn loan balance, these costs combine to add up to an effective interest rate of 18% or even higher.
Specialist funding for smaller developments
The tighter margins that come with smaller-scale developments make it even more important to sweat the details of costs.
Banks and larger non-bank lenders aren’t always set up to cater to smaller deals (<$5 million), so finding a lender that can efficiently handle smaller stuff will make a huge difference.
At Squirrel, we specialise in funding projects up to $3.5 million and, for bigger deals, can tap into our relationships across the lending spectrum to coordinate finance.
Keen to get things rolling on your next project? Check out our unique funding solutions or book a chat with one of our development lending specialists.
