Every so often, Mortgage Professionals will encounter a request from someone who wants to build their own home. Whether it be for a 2nd home to be used as a weekend retreat, or for a primary residence, there are those who desire to build rather than buy. And, in some areas, it appears the demand for these types of loans may be growing. The developing use and acceptance of telecommuting for work and the desire for better live/work balance is pushing this unique window of opportunity more into the light.
Of course, the big question faced by mortgage lenders and consumers both is – how does one go about trying to do this? Is it even possible or reasonable to do? And if so, how do you qualify? For the mortgage lender, there are also concerns regarding protecting their interest in the permanent mortgage loan, while the construction portion is carried out.
Well, rest assured, one can build their dream home and finance it too, with the mortgage professional being protected for placing the permanent mortgage for the client.
Knowing where to start is key in the process, and that begins with the Construction Lender. A good place for this can be a local community bank, who is comfortable and experienced with making short-term loans for land acquisitions and construction.
Typically, this is done in a two-step process. Whereby, a short-term construction loan is granted for the building and completion of the new home. Once the new home is completed, the construction loan is then converted to a permanent mortgage loan. Depending upon who the lender is, and what program is used, this conversion may take place automatically, or the construction loan may be paid off by a different lender, with a new loan. The customer can apply for both loans (construction and permanent) simultaneously, or if already pre-approved for the final mortgage loan, can use that mortgage loan approval as an important component for the underwriting of the construction loan.
Construction loans to build new end-user homes are designed to be short-term, usually up to 12 months in length. The approval process can take as little as two weeks, or may extend over a few months, contingent upon procuring a home builder and establishing a solid construction budget.
The loan is actually a provision of credit, known as a “draw note” whereby advances are made (or “drawn”) from available credit to pay for construction costs as they occur, and are billed for. In the beginning, the full amount of the approved construction loan is available to draw upon. Because no credit has been advanced yet, there is no balance owed or payments due.
Then, as each advance is taken, the amount of available credit will decrease. Conversely, the amount of the principal balance owed will increase. Interest accrues on the unpaid principal balance, usually calculated on a monthly basis. The interest accrued is typically repaid from a monthly payment, but some programs may allow it to be rolled to the end of the loan when the construction note comes due.
For loans set-up with monthly interest payments, the interest payment will increase each month, as the amount of the loan balance increases. The cost of the construction loan interest is estimated and included in the construction loan budget. It is usually paid for by advances taken from the available credit, however some lenders may require the borrower to service the interest themselves during the construction loan process.
The Construction Lender can also be a good resource for guidance during the construction process and may be able to recommend some builders that they have worked with in the past. The selection of the Builder can be the most important decision in the entire process. A reputable, well-experienced builder with many quality referrals and successful projects may prove to be invaluable! Additionally, most lenders will require the selected builder to meet a set of parameters, and provide documentation to support their abilities. These documents can include licenses, insurance, performance bonding and references.
Another key item to know about Construction Loans is the larger down payment requirements. Because the majority of the risk occurs during the construction process, the construction lender must apply a more conservative approach to underwriting the loan request. This is why the down payment requirement may be more, as compared to that of buying an existing home.
There are also situations where the borrower is not immediately ready to commence the construction process, but desires to purchase the property and hold it for an extended period of time, before later choosing to build. In these scenarios, lenders are required to classify the request as a land loan. Land, or “lot” loans as they are sometimes referred to, usually require even larger down payments, sometime as much as 30% – 50% of the purchase price. The good news is that equity gained by a large down payment and/or appreciation of the property over a period of time can be considered towards the down payment requirements of the construction loan.
Of course, knowing and understanding all of the particular nuances of the construction loan process may appear to be overwhelming. However, it does not need to be a daunting endeavor for the Mortgage Professional or their client. A well-experienced Construction Lending Professional will be able to navigate you through the activity, will be a committed partner to the mortgage professional, and make it into a positive experience for all involved.
So, the next time a Construction Loan Opportunity comes along, be encouraged! The process may prove to be simpler than you thought, and you will be providing a needed service that other Mortgage Professionals may tend to shy away from.
Joe McCoy
Joe McCoy first began lending money to folks back in 1988. Over his professional banking and finance career, now spanning 4 decades, Joe has provided hundreds and hundreds of bank loans in all forms, shapes and sizes. These include consumer, mortgage, small business, construction and commercial real estate.
He has served in voluntary and leadership positions for numerous charitable and business organizations, including Kiwanis, Rotary, Christian Churches, Chambers of Commerce, Community Business Development, Home Builders, Equestrian works for people with disabilities, and his favorite- Youth Sports.
In addition to lending money, Joe has also taught a variety of business and lending courses through the years, for the American Institute of Banking and the Center for Financial Training. He also conducts seminars and loan education for both Residential and Commercial Realtors, Mortgage Brokers, and Real Estate Investors.
Joe enjoys helping people navigate through the construction and commercial loan process, and working with them to achieve a successful lending relationship. He presently delivers his lending acumen and business development expertise for a local community bank as Vice-President of Construction and Commercial Lending. He can be reached at: [email protected]
