Construction Loans: Questions and Answers
It would seem that construction activity is still fairly high based upon the
number of calls that I get from people about construction loans. There are
a lot of calls from people just getting started, as well as from a number of
seasoned “construction veterans.” In a large number of those calls, I
hear some common questions. So I thought that I’d answer a few of them
here.
Q: How do construction loans work?
A: In general, just like every other loan. You sign loan
documents and money is funded into escrow. In the case of a construction
loan, only a portion of the total loan is released. The balance is
released either in preset “stages” or as workers complete portions of the
project according to a budget. The former is called a “draw” system
and the latter is called a “voucher” system.
Q: How are the payments calculated and who makes them?”
A: Commercial loans have the added security of an income producing
property providing the funds to pay the loan payments. For residential
loans, it’s the borrower’s income. When a property is being built,
there is no secondary source of repayment so the burden of payment would
normally fall to the borrower. But lenders didn’t want borrowers to use
up all of their funds in case something went wrong with the project, so they
created “interest reserves.” This is a chunk of money
set aside in the loan to do nothing but make the loan payments during the
construction process. The payment is based upon how much money has
actually been used or “drawn” at the time the payment is due. This is
not the case for private money lenders. They calculate interest on the
entire amount of the loan from the initial funding date.
Q: What’s a contingency reserve?
A: This is another chunk of money set aside in the loan to protect you
against cost overruns. Since it can take a year or more to complete a
project, the prices used to estimate the construction budget become less
accurate as time marches on. The contingency reserve is released a little
bit at a time during the construction process to cover inevitable price
increases.
Q: How do you calculate the maximum construction loan?
A: The maximum construction loan is based upon many factors:
Property type, stabilized value at completion, total costs, and equity invested
to name a few of the key concerns. For any given property type, there is
usually a maximum “loan to costs” and a maximum “loan
to value.” The key is this: The largest permanent loan
for which the property can qualify, assuming it is built and fully occupied or
valued, will limit the construction loan. This is because the construction
lender wants to be paid off at the end of construction and the way to do that is
with a permanent loan. This does not mean that if the permanent loan
exceeds the total costs of the project that you can get 100% construction
financing. Just about every lender is going to look for 10% to 20% of the
total costs to be funded by equity or cash from the borrower.
I hope that these few examples clarify some of the questions that you might
have concerning construction lending. I’ll cover more here in the
future. If you should have a question that wasn’t covered, email me at
your convenience and I’ll do my best to give you a complete answer.
About Author:“The Investment Property Insider,” works as a commercial mortgage broker. He publishes the weekly “Investment Property Insider”e-zine and blog, www.InvestmentPropertyInsider.com
Do you own real estate articles or stories and want to share with other investors?
You have chance to win
$100 Amazon Gift Certificates. We will give
away 3 prizes for top authors each month!
Email your articles or stories to:
articles@buyincomeproperties.com
© Copyright 2001 - 2010 by
BuyIncomeProperties.com
Visit
Real Estate Forums
for every real estate investing topics!
Enter Here
Top of Page
