• Single-family residential properties
• Multifamily residential properties
• Businesses and commercial properties
• Land, raw and developed
CONSTRUCTION LOANS GENERALLY DON’T COME IN NEAT, standardized packages like conventional mortgage loans structured according to strict government regulations. For residential properties in the U.S., however, certain parameters relating to construction or renovation of the property being acquired may be specified in the standard Uniform Residential Loan Application (Form 1003) required for government-backed mortgages. Financing for multifamily and commercial properties is more complex. Either way, all construction loans have certain basic features in common.
Here’s a brief overview of key points about construction loans.
THERE ARE TWO COMMON FORMS OF CONSTRUCTION LOANS:
• Construction loans obtained by the builder
• Construction loans obtained by the property owner
A CONSTRUCTION LOAN MAY FURNISH:
• Construction-only financing
• Construction-to-permanent financing, where the construction loan is converted to a longer-term traditional mortgage after construction is complete
CONSTRUCTION LOANS TYPICALLY REQUIRE interest-only payments during construction. The principal then becomes due after construction is completed or a certificate of occupancy has been issued. On a construction-to-permanent loan, the lender may schedule mortgage payments to begin when construction is finished and the builders have been paid.
CONSTRUCTION LOANS ARE USUALLY, BUT NOT ALWAYS, set at a variable rate and priced according to a short-term interest rate, such as the prime rate. As a result, interest rates on construction loans can change frequently.
DURING CONSTRUCTION, FUNDS ARE TAKEN FROM THE LOAN through a process known as a “draw.” The draw is the method by which money from the construction budget is paid out to material suppliers and contractors.
THE BORROWER, CONTRACTOR AND LENDER establish a draw schedule based on stages of construction, and interest is charged on the amount of money disbursed up to a particular date. Different lenders have different requirements for processing a draw.
MANY BORROWERS USE CONSTRUCTION-TO-PERMANENT FINANCING programs where the construction loan is converted to a mortgage loan after the certificate of occupancy is issued. The main advantage here is that the loan requires one loan application and one closing. These construction loans are sometimes called “all-in-one” or “one-time close” loans.
ANOTHER OPTION IS TO SECURE A SHORT-TERM construction loan, then refinance it into a conventional mortgage when construction is finished. This requires two applications and two closings.
OTHER COMMON CONSTRUCTION LOANS include fixed 15-year, 30-year, interest-only and variable-rate loans.
BEFORE PRESENTING THE LOAN APPLICATION TO THE LENDER, the borrower and the builder must prepare a strict budget which covers two general categories of costs:
• Soft costs—for expenses like architectural, engineering, legal and administrative fees, blueprints, permits, etc.
• Hard costs—for the “bricks-and-mortar” items like building materials and payments to contractors to build the structure.
NEARLY ALL BUILDING PROJECTS EXPERIENCE CONSTRUCTION DELAYS, so everyone involved must allow for delays and accommodate the changes in costs they inevitably bring. For this reason, the lender usually sets a schedule of regular inspections. A loan officer may visit the property monthly to monitor progress. If changes are needed, a change order is issued to document them.
ADDITIONAL DOCUMENTS TYPICALLY USED in construction financing include a Construction Loan Summary and Budget, Borrower/Builder Agreement, Construction Cost Breakdown, Draw Instructions, Contractor/Supervisor Information Form, Land Plat of Survey, Floor Plans and Builder Specifications, and Description of Building Materials. Many lenders will furnish a Construction Loan Document Checklist to assist in organizing the necessary documentation.