A couple folks have asked about construction loans, so I am going to type up some key points. Feel free to post questions or comments (e.g. in case I got something wrong).
What is a construction loan?
A construction loan is a short-term financing product that is typically applied to cover the cost of land + construction or just construction.
They come in different forms. Two of the more common are ‘construction-only,’ which just covers the build, and ‘construction-to-perm,’ which is going to cover construction and then transition into a more permanent financing structure after the build.
Key features
- Rate: Variable, determined based on prime + some premium.
- Term: Pretty aggressive maturity date (e.g. 12 months).
- Disbursement: Made directly to the builder, established through a draw schedule.
Underwriting requirements
- Specifications: Lenders are going to need enough details to estimate the value of the build, which typically is going to involve floor plans and some clarity around other components.
- Builder: They’re also going to do some DD on the builder involved.
- Down payment: The borrower is going to be putting down between 20-25% of the financing.
Key points
- If you’re looking to finance a build, there aren’t many alternative vehicles out there.
- There are more challenging underwriting requirements and a lot of structure around disbursements. This is both a pro and con - it may be annoying for experienced builders, however it can save a lot of inexperienced borrowers (and their banks) from disaster.
- Aggressive maturity date - working with a ticking clock can be both a pro and con. If unforeseen circumstances arise, you’ll have to go and work with the lender to adjust the maturity date; although the urgency created with the ticking clock probably helps get the build done on-time.