I’ve learned that there is not much information or resources available on the internet about construction loans. What’s the secret? Due to the economy, the structure of construction loans have also changed somewhat over the years and from institution to institution.
Receiving construction loans for spec homes has become more difficult and requires:
A Good Track Record
An Investor with Money
A large down payment.
It would be unlikely for you to receive a construction loan on your first spec building project. You will likely have to show a track record of at least one sell of a financed spec home before a bank will be willing to lend you money.
Where can I get a Construction Loan?
There are not many big institutions that write up construction loans. In our area, there are only 3 or 4 credit unions that will fund construction loans. Talk to a mortgage lender or agent to find out who is writing them in your area.
Construction Loan Application
Generally, these are the things that you will need to put together in order to apply for and qualify for a construction loan:
- Two most recent payroll check stubs
- Previous Two Years W-2′s
- If self employed, last two years of personal taxes & current Profit/Loss statement from business
- List of checking/saving accounts with current balances
- Copy of IRA, pension plans, stock statements
- Legal description of property, current tax assessment/tax amount parcel number
These are the basics in a construction loan application. There may be others in your specific loan.
What fees are associated with a construction loan?
Generally, if you are building a new home and need a construction loan, you will put up your purchased land as collateral for the construction loan. If your land works out to be at least 20% of the construction loan, than that will likely suffice for a down payment and you won’t have to bring any more money to closing.
Here are the additional fees associated with a construction loan:
Loan Origination Fee: Generally about 1.5% of the loan value ($4,500 on a 300k loan)
Underwriting Review Fee: About $200
Title Insurance: Appx: $700
Appraisal: Appx: $400
Credit Report: Appx: $25
Flood Determination & Tracking Fee: Appx: $12
Tax Service Fee: Appx $63
Construction Reserves Interest: Appx $3,000
Recording and Release Fees: $300
So, you can see there alot of different fees with a construction loan. These should be added to your loan value and not paid at closing.
Again, the only thing you will likely need at closing is your purchased land (if it equals 20% of loan value).
Course of Construction Liability Insurance
You will need to contact your home owners insurance agent and get a course of construction home owners liability policy. You can pay this separate from the construction loan or add it to escrow. Speak to your agent regarding the cost (varies greatly).
Will I need to pay on the construction loan during construction?
Some construction loan companies require you to make interest payments on your construction loan during construction. So, you will pay more gradually as the costs are expended into your home.
You can and should find a lender that is willing to convert the loan automatically to a mortgage after the home is completed. This means that you will NOT have to pay on the loan during construction. Once construction of the home is complete, you will begin paying on it as a mortgage.
How is the Construction Loan valued? (Construction Specifications - Cost Breakdown)
The builder on the project will need to submit to the mortgage company a construction specifications/cost breakdown. This is done after the bids are received. This will breakdown the anticipated costs of construction by each phase (ie Foundation – exterior – roof – floor – etc.).
During construction, the builder/lender will use a construction progress report that breakdowns the various phases of construction. After one phase of construction is complete, the lender/builder/owner will inspect the work and approve a draw amount on the loan. The lender then provides the builder with the specified amount and the builder pays the sub contractor. Generally, the lender will not be authorized to make a draw unless both the builder and owner sign off on the completed work.
Owner/Contractor Building Contract
A construction lender generally requires a contract between the owner/contractor that guarantees that the subs are being paid and that grants other legal rights to the parties. You can get one of these contracts from the mortgage lender.
At closing, the owner will also need to sign a construction loan agreement that secures the loan value with the land and home.
So, those are the basics of a construction loan. The greatest lesson that I have learned is to find people that you trust (builders/investors/lenders/sub contractors) and you will be fine. Difficulties sometimes arise when you are dealing with bad people.
Find a construction loan that does not require payments during the construction period. Put as much money down as you can afford when you close on the construction loan in order to save the costs of re-financing later.
by: Levi Barber