Know the Differences in Construction Loans
All Residential Construction Loans Are Not the Same
Many builders require customers to obtain their own construction loan. This passes the expense and credit risk during construction to the customer and allows the builder to charge a lower price for the house. The customer will usually apply for a construction/perm loan with a primary construction lender such as a bank or credit union. The builder may recommend a construction lender but construction loans should always be shopped.
Some builders will only work with certain construction lenders but that might not be in your best interest. Some builders may have their own mortgage company and may offer what may seem like special deals. At the very least you should compare the loan terms and costs at three construction lenders.
Mortgage brokers do not have construction loan funds and will pass the loan to a primary lender such as a bank or credit union. The borrower is typically better off finding the construction lender themselves so that costs and terms of the actual construction loan can be compared.
Construction Loan Variables
1. Loan to value (LTV) Value is based on a projected appraisal of a completed home. The appraiser will consider land value and cost to build and compare values with sales prices at similar properties. Usually the construction loan to value is 70%-80% of appraised value, not to exceed 100% of hard costs. Each lender has its own LTV guidelines. Look for the lender with the highest LTV ratio. You can always reduce the loan amount at the end of construction.
2. Disbursement at closing. This is the maximum amount of money the lender will disburse to the builder at the construction loan closing. These funds are to reimburse the builder for building permits and other up front costs.
The actual amount of the disbursement will be reduced by the amount of the borrower’s deposit amount paid to the builder. Each lender has its own policy about the amount to be disbursed to the builder at closing.
3. Construction loans carry a variable rate interest rate and the interest must be paid each month during the construction period. The borrower pays this interest out of pocket but in some cases the lender will allow the the interest to be added to the loan amount. Some lenders will allow this but appraised value has to support the loan amount with the interest added into the construction loan. This is a nice feature that will help your cash flow during construction.
4. Cost of Construction Loan Inspections. Generally there are six construction loan inspections and the fees charged for each of these inspections vary. Sometimes a builder will request an inspection too early and the borrower will be charged for a re inspection fee. Inspection fees are usually paid from the construction loan fund.
Inspection fees vary among construction lenders so make this part of your check list. Typically the inspection fees are $50-$75.
5. Construction Loan Administration Fee Some lenders charge a construction loan administration fee in addition to the construction loan inspection fees. Make this another item for your checklist.
6. Construction lenders charge a variety of construction loans fees that can be substantial. Such fees may include a modification fee, discount points, origination fees and lock in fees plus normal mortgage loan fees.
There are also many variables such as the interest rate during construction, when the interest rate changes, the construction interest rate index used, fixed rate versus adjustable rate during construction, to mention a few.
Primary Construction Lenders The primary construction lenders among national and regional banks are Bank of America, Wells Fargo, Chase, SunTrust, Regions and BB&T. Each has its own construction loan policy and fee schedule.
Each lender has a “Construction Loan Agreement” that you will sign at closing. Ask for a copy of the agreement before you apply for the loan so you can decide if you want to work with that lender.