Construction loans are structured differently from regular purchase money or refinance mortgages. In this article I will explain the entire process based on my extensive experience of originating and closing construction loans.
This kind of a mortgage can best be described as all inclusive loan, in that all expenses associated with the construction, lot purchase, closing costs and interest expenses are all added up to yield the total cost and then all ratios are calculated based on the total cost and the future value of the completed project.
The main components of a Construction loans are:
1- Soft costs of construction; consisting of architectural plans, engineering expenses and local authority permit fees.
2 Hard costs; which are all the actual physical costs of construction, including hook ups to utilities and landscaping.
3- Closing costs; consisting of origination and lender fees, title, and closing fees.
4- Inspection fees.
5- Reserves; consisting of interest reserve, which will make the payments during construction and contingency reserve which will be used in case of cost overruns.
6- Existing lot pay off. A construction loan is a first trust deed and as such all existing liens will have to be paid.
Regular purchase money or refinance mortgages are based on Loan to Value Ratio (LTV). Where as, Construction loans are based on LTV as well as Loan to Cost Ratio.
A very important factor to consider when applying for a construction loan with the intent of financing the purchase of the lot and the construction is the time line.
In order to do the appraisal of the subject property a construction lender will need a set of architectural plans, and in order to close the loan the plans must be submitted to the city or county.
One factor that makes the whole thing more complex is the fact that the way these numbers are calculated or the way the numbers are put together differ from one investor to the next.
In fact the calculations get complex enough that most loan officers in most lending institutions don’t even know how to calculate a loan amount, unless if they are experienced construction loan specialists. This normally results in last minute unpleasant surprises.
The problem most applicants of new home onstruction loans face is when at the 11th hour they get a call informing them of the final loan amount as calculated by an underwriter which may or may not be sufficient to meet the borrower’s needs, as in most cases insufficient loan amount means additional down payment requirements.
In short choose your construction lender wisley and avoid problems down the road.