In recent years contractor loans have become one of the main marketing tools in the new apartment market. The fact that sales of new apartments are at a low point makes financing benefits and contractor loans more common in order to encourage buyers to complete the transaction and provide an incentive to purchase in the new apartment market rather than the second-hand market. Nevertheless despite the scale of these loans buyers do not always know all the details of what is in fact a complex mechanism.

Moti Cohen owner and CEO of Precise Real Estate Marketing helps clarify the issue. In his words a contractor loan is neither a gift nor a trap. It is a legitimate and effective financial tool yet one born first and foremost from business and economic logic. The better the public understands the financing mechanism the interests of each party and the long-term implications of the deal the more informed decisions it will be able to make.

Let us begin with the reason buyers tend to favor the arrangement. It offers a path that allows entry into the deal with relatively low equity and defers payments to a later stage. This provides buyers with a financing arrangement unavailable in the second-hand market. One cannot ignore the main advantage of contractor loans says Cohen. They enable buyers with limited equity to enter the housing market with only 5%-10% equity and accumulate additional capital until delivery.

On the other hand there is also a clear advantage for the developer or contractor. A contractor loan allows the developer to receive a significant portion of the apartment price already upon signing the contract sometimes three to five years before delivery. For a real estate developer this represents a significant financial benefit Cohen adds. The developer replaces expensive bank financing credit that may cost 6%-12% per year with significantly cheaper funds originating from housing mortgages taken by buyers under contractor loans. This financing cost may stand around 4% per year since these are housing loans. The gap in financing costs forms one of the most significant economic value drivers for the developer.

At the same time there are several additional points worth knowing regarding contractor loans. First a contractor loan is in effect a balloon loan Cohen explains. The buyer commits today to a loan with the developer's financing bank yet at delivery will be required to repay it through a new mortgage or other financing sources. At that point the buyer's bargaining power with the bank may be limited. Second already at the time of purchase the buyer must undergo a full underwriting process exactly as required for any regular mortgage including purchasing life insurance and paying associated costs.

Finally Cohen notes that rarer deals also exist usually known to parties active in the earliest marketing stages. In such transactions it is sometimes possible to purchase an apartment under 5/95 or 10/90 payment terms without linkage to the construction inputs index and without any contractor loan. This model allows enjoyment of deferred payments yet without most of the risks involved in this type of financing and is therefore considered by many one of the most attractive purchase models available today.

In the bottom line in the real estate market as in any financial market it is not correct to ask only what is offered but mainly why it is offered.