Construction Loan 101

Written by Builder Finance Team Member | July 10 2019

This question & answer covers a topic we know well: Construction Loans. Answers are not meant to be exhaustive, but merely to touch on typical residential construction loans made to professional builders and investors working with general contractors. Construction loans to owner-occupants is not covered.

Construction Loan 101 Index:

How does a construction loan work?

How long does it take to close on a construction loan?

What does a construction loan cost?

Is a down payment required?

Is it hard to get a construction loan?

What is needed to get a construction loan?

When are low-doc construction loans offered?

What is a good way to find a Construction Lender?

What Does the Construction Loan Cover?

Who Can Get a Construction Loan?

Can I Use a Construction Loan to Build My Own Home?

How Do I Get Started with a Construction Loan?

How does a construction loan work?

A construction loan is a short-term loan to pay for construction and/or renovation A Borrower may direct the lender to close the loan at acquisition of the site or around the time when the borrower starts construction. Once closed, the loan term is usually less than one year; enough time to complete work and exit. Exit is expected to occur through sale of the house or, if keeping it as a rental, refinance. A few things to consider:

Draws. Lenders payout money as work is completed according to 1 of 2 general approaches: (A) sequential: borrower funds its share of costs first and then lender pays out for all remaining costs OR (B) pro-rata: borrower and lender each pay their percentage of costs along the way. At BFI, we believe approach “A” keeps things simple and results in reduced loan expenses.
Pricing. Most lenders will charge points based on the committed amount of the loan and charge interest only on drawn funds. But be careful – ask if a loan would have “Dutch Interest” or a “Reserve Account”. Dutch Interest means borrower pays interest on the committed amount – ouch! Reserve accounts may also create interest charges for funds borrower has not yet accessed.

How long does it take to close on a construction loan?

First the lender must order an appraisal. In order for a lender to order an appraisal, the applicant must provide a loan application along with plans, specs, budget and a survey or plat plan. Once the appraisal is received, the lender should be in a position to close a construction loan within a few business days.

What does a construction loan cost?

Builder Finance Inc., charges 4.99% for the first month, increasing half a point monthly, to a maximum of 7.99%.

Is a down payment required?

With Builder Finance Inc., a 0% down payment is possible. For example, if the land seller provides financing (asks for payment after sale of the house), the borrower may be eligible for a loan that does not require a down payment. Please ask our loan officers for details.

Is it hard to get a construction loan?

Builder Finance Inc., tries to make getting a construction loan easy. To better understand how we underwrite refer to our loan matrix or our online estimator.

What is needed to get a construction loan?

Lenders look at few key things:

Collateral: Applicant provides a budget, plans & specifications, and property information such as address and a survey. Lender orders an appraisal and looks at market characteristics.
Experience: Applicant provides resume(s) of key people including past and current projects. Lender wants to see that borrower knows what he/she is doing.
Borrower Credit: Applicant provides permission for a credit check, a list of references, and financial documents. Applicant also invests its own capital into the deal. Lenders want applicants with the capacity and inclination to repay loans in both good and bad economic times.
Character: This is how an applicant interacts with a lender. Lenders want trustworthy applicants that are not problematic. Bad character includes making inaccurate statements on lender forms.

When are low-doc construction loans offered?

Builder Finance Inc., can approve loans after only receiving limited documentation. For example, Builder Finance Inc., does not require financial statements and tax returns, but without those items, LTV will be constrained. If you don’t want a high LTV loan, it may make sense to ask your lender about this approach upfront.

What is a good way to find a Construction Lender?

Online searches are a great way to start. From there, look at websites and contact the lenders. A few things to help narrow the search:

Direct Lenders vs. Brokers: Sometimes it is difficult to distinguish between the two on a website, so always ask. Direct lenders lend money directly to borrowers. Brokers advise and help borrowers close loans with direct lenders.

Builder Finance Inc., is a direct lender. Builder Finance Inc., also works with brokers. Whether a loan will cost you more because of a broker’s involvement is dependent upon the agreement between you and the broker.

Project Type: Construction loans can be used for any property type but lenders often focus on one category to provide better expertise.

Builder Finance Inc., works in the residential category, specializing in loans on single-family residential or “SFR” houses (detached), townhouses, duplexes, triplexes, and quadraplexes. Any non-residential portions of a structure such as ground floor retail will be assigned no value for underwriting purposes. The Build New program is for new ground-up construction. The Fix-Flip program is for renovations of existing structures.

Borrower Type: What type of borrower are you? If you are looking to make money by selling or renting the project, contact Builder Finance Inc. We do not finance personal loans for a home you intend to build for yourself.

Speculative Construction (“Spec”) vs. Pre-Sold: If a buyer has not contracted to purchase the complete project, it is considered a Spec home. At Builder Finance Inc., most loans we make are Spec. Of course we also like to lend on pre-sold projects and can often provide a larger loan a pre-sale contract is in place.

What Does the Construction Loan Cover?

Construction loans cover a percentage of a budget that was agreed to prior to loan closing. To the extent that a project runs over budget, it is safest to assume that the borrower is responsible for cost overruns.

Who Can Get a Construction Loan?

Builder Finance Inc., lends to builders, developers, and investor-general contractors of all sizes. All lending is strictly for business purposes – borrowers that sell or rent their projects. Borrowers must be organized as a business entity – primarily limited liability companies (LLC’s). We DO NOT lend to owner-occupants.

Note that Builder Finance Inc., also lends to investors (foreign and/or domestic) working with qualified general contractors.

Can I Use a Construction Loan to Build My Own Home?

Yes, and we recommend you start by asking your local bank. Builder Finance does not finance owner-occupied projects.

How Do I Get Started with a Construction Loan?

Reach out to a few lenders by email or phone. Ask for the estimated loan amount and pricing. Ask why you should pick their program.

Are you ready to get started with a construction loan? Contact Builder Finance Inc. today.

Builder Finance Inc. is an Equal Housing Lender.

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