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Housing and construction champions announced

After launching the Department’s Red Tape Challenge ‘Housing and Construction’ theme last month, the Secretary of State is pleased to announce the appointment of Simon Randall CBE and Councillor Stephen Greenhalgh as Sector Champions. (continues…)
Department for Communities and Local Government: Housing news articles

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What You Need to Know About How Construction Loans Really Work

The loan process you follow when searching for a construction loan has some similarities to that of obtaining a regular mortgage. You will still be judged on your income, credit, savings and monthly debts just like a regular mortgage.

However, with a construction to permanent loan, there are a few additional factors that lenders consider. Since the home is not yet built, an “as-finished” or “as-completed” value must be established by a “plans and specs” appraisal.

When you go to get a mortgage on an existing house, you will also need an appraisal to establish the value and to insure that you are not paying more for the house than it is worth. With a home that is not yet built, this is doubly important. The lender needs to see what the projected home will be worth based on other homes that are similar in the immediate area.

Basically, for an appraisal prior to construction, you will deliver to your appraiser a set of home plans along with a list of materials you intend to use to finish the home, such as flooring, appliances, countertops, etc. Then, the appraiser will go to the vacant lot upon which you plan to build, and he will determine an appraised market value based on the recent sale of very similar homes in the immediate area.

In addition to the appraisal, the lender will also examine your proposed budget carefully to determine if there is enough money to build the home and if the builder (or owner-builder) is over-spending to build a home of that particular appraised value.

Each lender can have its own set of guidelines and parameters it uses to determine if you are under-budgeting or if you are over-budgeting. But, in general, the lender’s goal is to protect you and themselves from some potential disastrous scenarios: either an unfinished house or an over-built home in a market that won’t support the price.

Therefore, think of your construction loan as requiring two sets of approvals. First, you must be approved as a borrower. Second, the project you wish to build must be approved based on the appraisal and budget.

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And, typically, the qualifying guidelines, especially for owner-builders, are more stringent than for regular purchase mortgages. This is for two very simple reasons: risk and supply/demand.

There are thousands of loan programs out there for buying a house. You can have good credit, bad credit, low income, high debt or any number of other variables and still qualify for a purchase mortgage.

But the choices are more limited when building a home. Construction loans (and owner-builder construction loans in particular) are more risky for lenders. This is why not all lenders offer them. And, it is why those who do offer them can set tougher qualifying standards and be more particular about who they give their money to.

Risk, along with supply and demand, determines all mortgage pricing.

Remember that construction loans in general, and owner-builder loans in particular, are more complex than typical purchase mortgages. They will require more time to prepare for on your part.

And, they will take longer for your lender to process and get you to closing than normal. So prepare appropriately. If you understand the process before starting, and set your expectations accordingly, you will have a much more pleasant loan experience.

In fact, when considering the timeline required to close on a construction loan, keep in mind that many times the lender is forced to wait on you, the borrower. Often, the slowest part of construction loan planning involves waiting on the blueprints and the budgeting.

The underwriting of the loan cannot really begin until the blueprints and budget are complete. So, the lender is often forced to wait for the borrower to complete these items. This is not a bad thing. It is just an important point to remember when planning for your overall construction loan timeline.

Speaking of planning for construction loans, here is one last important point that you may not have considered yet. As the mortgage market has drastically changed nationwide over the last couple of years, one of the new mortgage industry catchwords that you will likely hear is “area of declining value.” Chances are you will hear quite a bit about this for the next year or two.

What does it mean if you live in, or want to build in, an “area of declining value?” Simply put, it means that the government has declared that your local area has seen significant enough drops in average home values to place your area on a watch list.

Mortgage lenders have adopted different guidelines for doing business in these areas – and all lenders are slightly different.

Be prepared: if you find yourself in one of these areas, you will likely have a different set of qualifying standards than if you were not in a declining market area. This is not a reflection of you as a borrower, but in the general market conditions that currently exist.

Overall, if you are considering building your home and need construction financing, hopefully this brief article helped you recognize some of the key differences between the simpler purchase loans to which most people are accustomed and the more complex construction to permanent loan that will be required for building your home.

What are the key things to remember? First, understand that the construction to permanent loan is more complicated and may take a bit longer to complete. Second, be aware that there are basically two sets of approvals that are required: your credit approval as a borrower plus the approval of your project’s budget and appraisal. Finally, be on the lookout for areas of declining value, as it might affect your construction loan in some way or another.

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Commercial Construction Loans – Abandoned Deals

Commercial construction loans have taken perhaps the hardest “beating” in the current credit crisis.  Bottom line, banks do not want too or cannot take on the additional risks that come with construction loans. 

Further, we have seen many commercial construction loans get canceled.  And we are referring to loans that have closed on the land acquisition component, than the funding bank backing out off the rest of the project.  This is something we have never seen before.  This puts borrowers in particularly difficult positions, as they have debt payments on unfinished projects and puts a stain on the deal for other potential lenders.  As they will all start off with the assumption that the borrower had done something wrong. 

It also puts the funding bank in a very bad position as well, as they have a lot of liability to deal with and stand a very good chance of being sued for damages by the borrower.  They have not honored their commitment.  Also, by not completing the project they further hurt themselves, due to the fact that a good portion of these borrowers may not be able to find financing and will default on their loan. 

Commercial Construction Loan

For example, we recently worked on a project that we could not close.  The project was an automotive repair type construction project, ground up.  The borrower purchased/closed on the acquisition of the land at 0,000 and had financed 0,000.  The other 0,000 was supposed to be the total down stroke of the entire project (not just the land) which had an additional 0,000 construction component to it (it was an SBA loan, 85% financing).  That was basically all of the cash the borrower had.  The bank pulled out and now the borrower has a ,500 a month interest only payment and very little options on how to entice another bank to come along and complete the deal. 

As far a potential solution on the above transaction (and other similar ones), is for the borrower to bring on a partner.  Though not ideal for the borrower, it is probably the only way to get the above commercial construction loan closed and to avoid a complete financial disaster.  On the above transaction, all of our sources wanted to see cash reserves, post close, of at least 5% of the ,000,000 project cost and to come into the deal with another 10% injection.  He was at 85% financing and needs to be at more like 75%.       

This is just one example.  Some of our clients that have come to us have had better “endings” to their stories.  For example, we just knew of the sources that would fund their loan requests as is, with no further cash injection or need to bring on a partner.  Bottom line, borrowers that have an “abandon” commercial construction loan, need to figure out a solution, as soon as possible. 

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How to Botch a Home Loan Application: An Example from Owner Builder Construction Loans

Getting a loan pre-approval from a lender is a quick, easy process. Typically, you fill out a few pages about your financial situation, the bank runs the numbers through a computer approval system, and you’re pre-approved the next day.

So, how do so many people mess it up so badly? Simply put, people lie (either to themselves or about themselves) when filling out a loan application.

We’ll look at examples from customers who applied for owner builder construction loans, but the principles of filling out a home loan application will apply equally well to anyone who wants a loan to buy or refinance a home.

Owner builder construction loans are for individuals who wish to build their own house without having to hire a general contractor. Therefore, they manage the sub-contractors themselves and oversee the project.

However, an owner builder loan application is no different from a standard purchase loan or refinance loan application. Almost every bank across the country will use a form known as a Uniform Residential Loan Application, also known as a 1003.

On this 4 or 5 page form, you simply fill in information about your financial situation. On the first page, you’ll cover simple info about the property as well as information about your address, phone, social security number, etc.

The second page will cover your work history and income. The third page will cover your assets and your monthly debts. All in all, the process is not difficult. In fact, anyone, whether you are an owner builder or someone looking to refinance an existing home, can fill it out without too much difficulty.

Therefore, the mistakes that are seen on owner builder loan applications be due to reasons other than misunderstandings. Indeed, almost every mistake occurs when an owner builder decides to embellish his qualifications or thinks it’s unimportant to be as accurate as possible.

You may be asking yourself why it’s such a big deal. Why should you care if you round off your numbers on the application? After all, it’s just a pre-approval. The bank will collect all of the real paperwork later on.

Here’s an example from a recent owner builder loan. A loan applicant decided the pre-approval was not worth his time to provide detailed information about his financial situation. He rounded up his income and failed to mention the child support payments that he is obligated to make each month.

In the case of this owner builder, the application was pre-approved quickly and easily. Why wouldn’t it be? On paper, everything looked great. But, when the bank started collecting the official income documentation and discovered the child support payments being deducted from the pay stubs, the borrower no longer qualified for the loan.

Not a big deal, right? Wrong. This owner builder had already put money down on a piece of land that he wanted to buy as well as purchased blueprints for his new home he wanted to build. Imagine the frustration and anger he caused himself when he found he was no longer qualified for the loan and he lost the money he wasted on blueprints.

Even though this is an example from owner builder construction, it still applies to anyone filling out a Uniform Residential Loan Application. Imagine you are buying a home and make a large earnest money deposit on the house you want based on getting pre-approved from your bank. Now imagine that your pre-approval is based on inaccurate information that you told the bank. In fact, imagine that you also wasted money out of your pocket for the home inspection and the appraisal.

So, what can you do? Whether you are looking for an owner builder construction loan or any other type of mortgage: tell the truth.

Do not think that embellishing your financial picture will help. It will only hurt you in the long run when the lender discovers the errors. You are better off getting an accurate pre-approval based on accurate information.

And, if you are unsure about your exact income numbers or your exact amount of assets, then estimate conservatively. That way, if your income or assets turn out to be higher than you estimated, you will still be approved and qualified for the loan program you are counting on. It works for owner builder construction loans. It works for refinances. It works for home purchases. It works.

In fact, one great piece of advice is to supply copies of your W2 forms, your pay stubs, and your asset statements when getting your pre-approval. Many customers, not just owner builder customers, don’t want to take the time to do this, because it’s a hassle. But, your loan officer can use these documents to ensure the pre-approval is based on accurate calculations. Besides, you are going to have to submit these documents for underwriting anyway.

For example, a recent owner builder borrower took the time to submit his pay stubs when he applied for his construction loan. A big portion of his income came from bonus pay. It turned out that he could only get credit for the average of his bonus pay over the last two years, in addition to his full base salary. Therefore, his gross income was calculated slightly lower for the loan that he thought it would have been.

In this case, the owner builder fortunately still qualified for the construction loan. However, you can see how miscalculating income can lead your pre-approval to be inaccurate. Therefore, don’t take any chances. Submit your documentation paperwork when you fill out the application.

So, if you are thinking of applying anytime soon for a mortgage for a home purchase or a simple refinance, then take a lesson from the world of owner builder construction loans. Do not discount the importance of providing accurate information about your financial situation on the Uniform Residential Loan Application. The pre-approval is a quick and easy process, but it’s also a very important one. Owner builder construction loans are no different in this respect.

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Shopping for an Owner Builder Construction Loan: The Features You Need to Look For Before Building

Most new homes in America are built by builders or developers who build the new home with their own money or lines of credit in order to sell the finished home to the new customer. The new buyer simply obtains a regular “purchase money” loan and buys the house.

This is the simplest form of construction financing. Of course, the builder’s borrowing costs are built into the price the new home buyer pays.

Increasingly, however, this form of financing is becoming rarer. Often, builders are becoming more reluctant to use their own funds to build for someone else as their banks are tightening their lines of credit and making it more difficult and expensive for them to get the needed funds.

As builders become less likely to fund your new construction, prospective new home owners who wish to build a custom home are forced to fend for themselves when it comes to construction financing.

Enter the construction to permanent (CTP) loan.

There are a wide variety of construction loan choices out there. And many of them are woefully inadequate for most people – especially if you want to act as your own general contractor (known as owner-builder construction).

Local banks tend to be very conservative and will not even consider lending their money unless you fit exactly into their guidelines. This typically means having a fixed price contract with a licensed and approved builder, selling your current home prior to qualifying, and even making a large down payment or owning the land first.

Occasionally, a local bank will give you permission to be your own contractor, if you jump through enough hoops for them. They may require an extra large down payment or that you own the land free and clear before they lend you the money to build. In the end, most local bank’s construction loan programs will have one or more restrictions that make their programs unusable, more restrictive and even more expensive than a good alternative.

As an owner-builder, your search for a construction loan should be focused on finding the loan features that will best fit your scenario. Finding this type of program gives you the greatest chance of success and your best opportunity to save money on your project.

Within the world of owner-builder construction loans, there are only a handful of options that make sense. Some of the features that should be most important are:

o Ability to be your own contractor without needing to make a large down payment – if any at all. “Large” means anything more than 5% for a conventional size loan and 10% for a loan up to ,000,000.

o No “consulting fees” or monthly “administrative” fees charged to you just for doing a loan. Please understand, you need to expect to pay for an owner-builder loan in the form of origination or discount fees, but you should not also need to pay a consulting fee.

o No requirement to sell your current home before you can qualify for the new construction loan. Many lenders will force you to sell your current home before you start building the new one, meaning you will be forced to move twice in a short time just to get the loan.

o No payments, interest or other, while you build. The best CTP loans allow for an “interest reserve” to be built right into your new loan so you are not forced to make both your current home’s payment plus the new one. Most programs that allow for an interest reserve also allow you to choose to make the monthly interest payment if you want.

o No upfront or “application” fees. Avoid any lender who requires any kind of upfront fee or “deposit” of any kind.

o Easy draw administration and unlimited draws. This means easy for you, the owner-builder, not the bank or your sub-contractors. After all, if you can’t get access to and control your money, all the other terms really don’t matter.

o One-Time closing. The best construction loans allow you to close only once for both your construction funds and your permanent mortgage. This will save you several thousand dollars in the long run.

o A staff of professionals who understand both construction and construction financing. Ask the person you are speaking with how many homes they have built themselves as an owner-builder. If you are dealing with a loan officer who has never built his or her own home and cannot speak to you from specific experience, you should look elsewhere.

The importance of working with knowledgeable professionals cannot be stressed enough. Half of the battle is learning to ask the right questions.

Note that the above list did not mention anything about construction interest rates. It is not that rates are not important; it is just that they are among the least important features of a good owner-builder construction loan.

This does not mean that owner-builder loan interest rates are necessarily higher than other construction loan rates – they will probably be about the same. But, who cares? It really shouldn’t matter to you if the interest rate during the period of construction is the same, a little lower, or even a little higher than a construction loan in which you are required to hire a builder.

Why? There are a couple of reasons, actually.

First and foremost, you are seeking a loan that will enable you to save tens of thousands of dollars by acting as your own contractor. The tiny (and it is tiny) difference in interest you will pay over a six to twelve month period is meaningless when compared to what you will save by being your own GC.

Second – and this is important to remember – despite the fact that every potential owner-builder is positive that he or she will build successfully on time and under budget, the reality is that owner-builder loans represent the most risky category of construction loan a lender can make. That is why there are so few available to start with. And, that is why you need to be prepared to pay a little more for the privilege of getting one of these loans.

Smart owner-builders understand that they need to focus on that “big picture.” Your goal is to build the exact home you want, your way, while saving tens of thousands of dollars. If the vehicle you need to reach that goal costs a little more, why should it matter? It is important to remember that:

A) Construction loans are short-term loans and the rates are therefore tied to short term funds – typically the prime rate. As the prime rate goes up, construction rates* will follow. And, vice-versa.

B) Owner-builder construction loans are very risky and very specialized. Accept this fact and the fact that you may pay a little more for the privilege of having access to this type of money.

C) Your permanent rate, and the choices you have related to that, is the more important thing to consider when looking at rates.

D) Rates are the least important feature to shop for. Remember to focus on the features that will benefit you the most and help you accomplish your goal – the big picture!

The smart shopper shops for loan features, not interest rates. The features that an owner builder needs are not necessarily the same as those a borrower hiring a general contractor needs. Refer back to the list of important features above as you examine loan programs. And always remember that you are in charge during this process.

Tags: Before, Builder, Building, Construction, Features, Loan, look, Need, Owner, Shopping

What to Look for from Nationwide Construction Loans

Construction loans are a bit different than other types of loans. A construction loan can be applied for either a residential project or a commercial project; however, you have to be clear about the project type before you can get the loan that you desire. Unlike a loan that you might get at a traditional bank for remodeling a room in your home, a construction loan is provided by a speciality company that understand all of the ins and outs of california construction loans. Additionally, the way you pay back a construction loan can be far different than a more traditional loan, so you have to be aware of that as well.

One of the first things that you will want to look for from california construction loans is the ability to utilize a one time close option. The one time close option allows you to roll your construction loan and your mortgage loan into one loan so that you only pay fees, such as closing costs and other associated fees, a single time. By using this option you could literally save thousands of dollars on your loan.

Another thing that you will want to consider is a construction to perm or permanent loan. This type of loan allows you to carry on your construction loan after the construction is completed. Many california construction loans will offer you this option and it is ideal for those individuals who are getting a residential construction loan versus a commercial loan. You see a construction loan is a short-term loan and has to be paid back in four months to two years depending on the type of loan. However, a construction to perm or permanent loan allows you to change that into more of a mortgage type loan, which allows you to make payments over time like you would normally expect to do.

You will also want to look for a cash out finance option from california construction loans. The cash out finance option allows you to take out a construction loan that covers your current mortgage and then some. Basically it is a new mortgage for your home. You will receive a loan amount that is higher than your mortgage amount, pay off your old mortgage and use the remaining money to remodel your home. You then pay your monthly payment just like you used to with your original mortgage.

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Demystifying Construction Loan Underwriting Criteria

Construction loans are story loans. That means the lender has to know the story behind the planned construction before theyre willing to lend money. To adequately tell the story, the borrower needs to provide the lender with the following critical documents.

Construction Cost Breakdown: When underwriting a commercial construction loan, four major categories of costs are involved:

1. Land Costs are the total costs associated with acquisition of the land.

2. Hard Costs are direct contractor costs for labor, material, equipment, and services; contractors overhead and profit; and other direct construction costs.

3. Soft Costs are cost items other than hard costs. Soft costs generally include architectural and engineering, legal, permits and fees, financing fees, construction interest and operating expenses, leasing and real estate commissions, advertising and promotion, and supervision.

4. Contingency Reserves are always built into the budget to ensure the project will be completed if there are cost overruns. This contingency is normally calculated at 5% of the total cost of construction.

Draw Schedule: Commercial construction lenders generally provide a schedule of draws (a periodic advance of funds), either at regular intervals during construction or upon completion of specific segments of construction. The borrower should be prepared to provide the lender with a draw schedule based on timing and costs of the project.

Feasibility/Marketing Study: Developers conduct market studies to determine the best location within a jurisdiction and to test alternative uses for a given parcel of land. Jurisdictions often require developers to complete feasibility studies before approving a permit application for retail, commercial, industrial, manufacturing, housing, office or mixed-use projects.

Architectural Drawings: Lenders require a complete set of drawings for the proposed project, including, among other documents, a site plan, floor plan, side and front elevations, as well as mechanical and electrical plans.

5-Year Financial Projections: The experienced developer will prepare a comprehensive financial model for the project, including five years of projected data required to prepare standard financial statements (income statement, balance sheet and statement of cash flow). In addition, the lender will require a five-year summary of these financial statements.

Company and Personal Financial Statements: Every commercial construction lender will require current and historical (usually three years) financial statements from both the company requesting the loan and the companys principals.

Following are the bases under which a commercial construction loan is underwritten.

Profit Test: Prudent commercial construction lenders will require an internal rate of return (IRR) to the sponsor of at least 20% over 5 years following completion of the project. Lenders also will require a feasibility/marketing study to support the projections used in the IRR calculations.

Loan-to-Cost (LTC) Ratio: Commercial construction lenders often will not trust the appraisal of a proposed property. Instead, they will look to the LTC ratio (percentage of total cost the construction lender is being asked to cover). Traditionally, commercial construction lenders will only lend up to 80% of total cost. If a property type is out of favor with investors, however, some commercial construction lenders might consider no more than a 70% loan-to-cost ratio.

Debt Service Coverage (DSC) Ratio: To determine if the takeout loan will be large enough to payoff the construction loan, the construction lender will compute the DSC ratio. This ratio is computed by dividing the projected annual net operating income by the annual debt service (principal and interest payments). The net operating income of the property is the income left over after operating expenses such as taxes, insurance, repairs, and management costs, plus estimated vacancy losses, collection losses, and replacement expenses, such as a new roof or heater. In general, the DSC ratio must be larger than 1.25. In other words, net income from the project must be at least 25% larger than the projected annual debt service.

Net-Worth-to Loan Size Ratio: Finally, the lender will look to the developers net-worth-to-loan-size ratio. Generally, the developers net worth should be at least as large as the loan amount. The ratio is calculated by dividing the developers net worth by loan size. This should be greater than 1.0. During recessions, banks often require this ratio to be as high as 1.5.

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Tags: Construction, Criteria, Demystifying, Loan, Underwriting

Introduction to Construction Home Loans

If you are planning to buy land and then build your dream house based on your own customized and specific requirements, then a construction home loan is something that is likely to suit you the best. Since the actual construction can take considerable time, you are not likely to need all the money that you are planning to invest in building at one go. It is therefore wise to choose construction home loan as the option that allows you to withdraw the loan amount in phases, as the building is completed. In most cases, a construction loan is divided into five phases. These are typically purchase of land, completion of flooring, completion of the roof, lock up and final. You may need to specify the home loan option that you would want to revert to once the five phases are complete and the entire amount of the construction home loan has been withdrawn. While the interest rates charged on a construction home loan tend to be slightly higher than a variable home loan, the overall package works out better since you are only pay interest on part of the construction home loan that you have withdrawn. To avail of a construction home loan you will need to provide proof of council approved plan for a fixed price contract for the building. Most builders are happy to provide this in a phased manner so that the construction loan payment releases can be scheduled. At the completion of each stage, a real estate valuer assigned by the construction home loan lender shall visit the property to guarantee the stage of completion. In case of a delay in schedule or unforeseen payments, you can apply for a line of credit for the construction home loan, if need be.

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Plan New Business Ventures Through Commercial Construction Loan

Construction is one of the most daunting aspects of business. It involves huge capital investment. An entrepreneur is not always sufficient with money to carry out construction and other renovations in his office. Your problem of scarcity of funds will become obsolete, if you opt for a commercial construction loan.

Commercial construction loan is the biggest way of financing your business plans. This loan is generally given to entrepreneurs, who wish to construct new buildings for commercial purposes, renovate premises, and buy business sites or commercial buildings.

Commercial construction loan can be secured as well as unsecured. Secured commercial construction loan requires you to place collateral. These are also called as commercial mortgage. These loans are provided at better terms, rate of interest and flexible repayment schedules. Unsecured commercial construction loans do not require collateral.

The rate of interest charged on a commercial construction loan is either fixed or variable. An entrepreneur is always advised to choose a fixed rate as it helps them in efficient business planning and budgeting because they know how much they have to pay every month. With a variable rate there can be fluctuations. It can increase during the term, as a result you will be required to pay more.

Before providing you a commercial construction loan the lender will give a look at your income and existing debts. He will also consider certain other factors like-:

• Collateral placed
• Credit score
• Repayment ability
• Reason for taking the loan
• Business investments
• Length of ownership of the company
• Number of partners, employees etc.

Besides the above mentioned factors the loan provider would require the borrower to present a few documents before him. The loan application must be in the form of a request. It must consist of the amount to be drawn from the loan, purpose of taking the loan, amount of working capital in hand etc.

Commercial construction loan when used for purchasing real estate, constructing new commercial buildings or renovating premises would require the borrower to give the business profile to the lender. Accurate information about present debt balances, payment modes, date of maturity and the collateral used(if any) to secured other loans is to be provided. The lender may also ask you submit preliminary environmental reports, property appraisals etc.

If the entrepreneur is to start up a new business, the business plan is vital. It should include details on cash flow projections for first 24 months. The information must be to the point. The business plan must also provide information on how it would be helpful for the entrepreneur to repay the loan.

Shop around the financial market before applying for a commercial construction loan. Do not forget to consider the option of online loan providers. Searching for a lender online will help you secure an appropriate and hassle-free loan deal.

Business is uncertain. Estimate high, spend less and you can bring in new innovations in your business.

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Construction Loans: Questions and Answers

It would seem that construction activity is still fairly high based upon the number of calls that I get from people about construction loans. There are a lot of calls from people just getting started, as well as from a number of seasoned “construction veterans.” In a large number of those calls, I hear some common questions. So I thought that I’d answer a few of them here.

Q: How do construction loans work?

A: In general, just like every other loan. You sign loan documents and money is funded into escrow. In the case of a construction loan, only a portion of the total loan is released. The balance is released either in preset “stages” or as workers complete portions of the project according to a budget. The former is called a “draw” system and the latter is called a “voucher” system.

Q: How are the payments calculated and who makes them?”

A: Commercial loans have the added security of an income producing property providing the funds to pay the loan payments. For residential loans, it’s the borrower’s income. When a property is being built, there is no secondary source of repayment so the burden of payment would normally fall to the borrower. But lenders didn’t want borrowers to use up all of their funds in case something went wrong with the project, so they created “interest reserves.” This is a chunk of money set aside in the loan to do nothing but make the loan payments during the construction process. The payment is based upon how much money has actually been used or “drawn” at the time the payment is due. This is not the case for private money lenders. They calculate interest on the entire amount of the loan from the initial funding date.

Q: What’s a contingency reserve?

A: This is another chunk of money set aside in the loan to protect you against cost overruns. Since it can take a year or more to complete a project, the prices used to estimate the construction budget become less accurate as time marches on. The contingency reserve is released a little bit at a time during the construction process to cover inevitable price increases.

Q: How do you calculate the maximum construction loan?

A: The maximum construction loan is based upon many factors: Property type, stabilized value at completion, total costs, and equity invested to name a few of the key concerns. For any given property type, there is usually a maximum “loan to costs” and a maximum “loan to value.” The key is this: The largest permanent loan for which the property can qualify, assuming it is built and fully occupied or valued, will limit the construction loan. This is because the construction lender wants to be paid off at the end of construction and the way to do that is with a permanent loan. This does not mean that if the permanent loan exceeds the total costs of the project that you can get 100% construction financing. Just about every lender is going to look for 10% to 20% of the total costs to be funded by equity or cash from the borrower.

I hope that these few examples clarify some of the questions that you might have concerning construction lending. I’ll cover more here in the future. If you should have a question that wasn’t covered, email me at your convenience and I’ll do my best to give you a complete answer.

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