Definintion of a Construction Loan
A construction loan is a temporary loan which is used to build a home (or other project). Sometimes called "staged funding," the loan is set up to be drawn on (funded) in stages of completed construction, with inspections prior to most draws. Monies that are funded are based on the percentage of completion of the project (when the project is 50% complete, the builder should be very close to 50% funded). This loan can be done by a bank for a builder to resale the home (called speculation building) or can be done under a contract with a buyer already in place (custom building).
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Bank Requirements for Construction Builder
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Construction lending is usually funded for a builder who needs to build several homes in a development simultaneously. The bank will pay close attention to the market for the particular price range, size and style of home he wishes to build. When he meets with the banker, he will show plans, appraisals, turn time (timeframe to complete) and cost to produce the projected homes, and whether he will be building more units. The bank will look at his building history, homebuyer references, his insurance, credit, supplier references, how the homes will be marketed, and average sale timeframe that a home is marketed before selling in that particular area.
Builder Requirements for Construction Loans
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When a builder visits a construction bank to obtain "spec" construction loans, the construction bank will make its decision on what percentage of the value to lend on each project (home). It looks at the strength of the builder (as mentioned above). If the homes do not sell, the builder is the owner and will be responsible for payment to the bank. He will incur interest on the loans each month during construction, but most banks allow monthly interest to be added to his loan balance so he doesn't actually pay it each month. Building project loans are "interest only" each month after construction (until someone buys the home). For each "presold" contract (the home is sold either before or during construction) the builder can produce, he can be allowed another construction loan.
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Buyer Benefits for "Presold" Contract
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An interested buyer can make an offer on a home before or during construction. The builder may already have his construction loan in place, but knowing that this one is presold, the burden of ownership of many homes is reduced. The builder might choose to offer upgraded features to entice a buyer to commit (write a contract) early. Upgrades might include higher-quality floor coverings, appliances, light fixtures or interior and exterior trim. The buyer can select colors and shop for specialty items that fit within the builder's budget. The buyer can add her own extra touches, making the home more customized to her liking.
Buyer Requirements for "Takeout Letter"
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When a home is presold during the construction stage, the buyer can negotiate price and upgrades. In exchange for these benefits, the builder may require that the buyer visit his construction bank (or other lender) to prequalify for the new loan prior to the builder accepting the contract. The bank will look at the buyer's credit history and scores, debts, income and down payment money. This is to be sure that the loan can be closed at the home's completion. This visit for preapproval should produce a "takeout letter" which is a loan approval to take the builder out of the loan at the home's completion.
Construction-Perm Loan for "Custom" Building
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If a person is interested in building a home, and has already determined the plan she wants, it may be advantageous to consider a construction-perm loan. A construction-perm loan allows for the construction loan and the permanent loan to close at the same time, saving one set of closing costs. If this person already owns her land, the land value will act as down payment. This person actually gets the construction loan herself and can hire a builder to partner with. The contract will allow for all of the costs to build the home and to cover the builder's pay. At the end of construction, after all final inspections, the construction loan simply modifies into a permanent loan with a predetermined interest rate without another closing. This loan saves lots of closing costs and the stress of requalifying for a permanent loan. This is considered custom building.
Commercial Construction Lending
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Commercial construction lending allows for the building of new commercial building that is not a one- to four-unit residential property. Commercial construction lending can also be used for rehabilitation or remodeling of existing buildings and projects used for any business purpose. This type of commercial lending is much larger and longer-termed than residential. The loan process is much more complex than residential as the construction bank must evaluate the strength of the business requesting the construction loan as well as the outcome of the property being built or remodeled. The bank will look at what the impact of the project may have on the business, the community, and how the business can support the added debt. Apartments, churches, hospitals, schools, shopping centers, malls, and any other building used for business purposes fall into this category. Loan amounts can soar into the millions of dollars, making the evaluation for approval a slow and complex process.
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