How do deposits work with construction to perm loans? (insurance, loan, interest rate)

[ma91pmh]

let's say I take out a $500k construction to perm loan where $100k is to purchase the land lot, $400k for building, and for arguments sake the assesed value of final house is $625k. Let's just say for simplicity also the draw schedule is say $200k upfront to buy lot and get started then $100k per quarter so that at the end of twelve months when house is done I've borrowed all $500k.

Do I need to put up right up front $100k (20% of the total commitment). Or do I have to put up 20% at each stage ($40k then $20k, $20k, $20k). Or is it even based off the assesed value? (optimistic!) Just curious how technically this would work if we choose this route

[chet everett]

If you investigate how construction loans work it will become apparent that no sane lender will allow you to have a mortgage for the land portion that is anywhere near 80% -- many will only lend if there is at least 50% equity in the land. Some will specifically require the land is owned without any liens, as vacant land is very very very very poor collateral.

The lender will also require that any applicant for a construction loan have very solid liquid reserves. 20% is an absolute minimum for most lenders, and many will want to see specific builder's estimates and some solid reserve for cost overruns. Lenders may require that these reserves be escrowed, so that they can become the down payment for the standard mortgage. It is very unlikely that a lender would allow you "ladder up" the escrow account, as they want to have their as a "life line" to finish the house if anything goes haywire. The most critical / costly phases of construction are nearer the beginning. Should your personal situation change and the lender be stuck in foreclosure they want to be able to FINISH the home out of the escrow / reserves... {Some lenders will also want insurance / surety bonds for construction that is especially costly...}

The "draws" will be closely monitored and the lender will want proof that the builder is neither behind schedule NOR so far ahead of schedule that the borrower is stuck with a finished home and their old home / renting. No sane lender will allow the borrower to just take the draws on a time based agreement -- the major work phases, such as site prep, foundation, rough framing, fully enclosed exterior, permit based inspections for plumbing/electrical/insulation, conditional occupancy, and final finish will all be important milestones and the lender may even have third party or lender employee out to make these decisions.

Once the house is completed AND IT APPRAISES OUT, the lender will then convert the borrowed amount to a mortgage. The lender will require 20% equity and if the reserves had to be used from escrow that will require even more cash. There are no real easy ways to avoid these requirement, as new construction has fewer alternative lenders and lenders really really hate to try and foreclose on an unfinished house as very few people will have the CASH needed to buy such a place and no other lender will write a mortgage for unfinished new construction...

Builders with the financial strength to underwrite buyers have a HUGE advantage in these conditions.

[ma91pmh]

Thanks. So I think what you are saying in general is that in my example above the best I can expect is to be able to finance $50k of the land value, and probably zero.

Try help me put it into simple numbers. I appreciate the lender won't make preset draws but I was just trying to put some figures together to highlight. Let's say I pay $100k cash for the lot, then I want to finance $400k of construction costs. You're saying I need to put up 20% of that myself (so another $80k) or "simply" have an additional 20% of cash reserves (i.e. have the money in the bank but not put it up?) The latter would be fine, the former would essentially mean putting 40% up front and that would not work.

Then the 20% equity requirement comes at the end based on appraised value then, so yes it could have tanked and then you'd need to put up more cash I presume

[chet everett]

If you find a lender that is doing new construction loans you also need to understand what sort of limits they have. If they will hold onto the mortgage in their portfolio after construction they will probably be less concerned with things like the FHA jumbo limit, but if their intent is to eventually resell the loan that would be a factor.

The whole process is messy -- if there is a vacant lot that you have in mind that is not part of a development and the access to utilities is not there then the lender may require that you agree to have those improvement done in XX days and all at your cost -- not with financed money and not with any portion of the downpayment.

If the lot is "ready to go" you MIGHT get 50% financing, but again the lender will try and verify that "worst case" they can resell this lot in reasonable amount of time for something close to what they lent you.

The whole idea with the requirement for the cash reserves is that the lender would use that to finish up the construction - they will generally want that in an escrow account so that is money that you will have to keep liquid in some low return account, so it might as well be the bank's money until the project is complete. If the thing appraises out and they do not need to tap the escrow then the money would go back to your control. Back in olden time this structure was common, then the crazy easy money saw the lenders loosen up, and now those lenders still doing direct lending for new construction are much more in the CYA mode...

As you surmise, should the current prices FALL the lender would be screwed with a brand new home underwater -- thus the scarcity of such loan offerings...

The general formula that "standard" mortgages do not work for lenders with new construction -- the value of the "thing" should be increasing pretty much daily, but in the current conditions lenders have to account for the very real possibility that even well paid borrowers can have their personal situation shift dramatically. Further even in good time the extra cost of administering new construction loans meant that they would have to charge a higher interest rate. To soften this the loans typically were non-amortization types, so you were only paying interest until it converted to the amortizing mortgage upon final sign off. The "risk window" is still about a year or so, as something like 90% of all new home construction takes less than that timeframe. Some of the community banks / credit unions like the profit potential, but do not expect this to be a "fill it out over the internet" kind of thing as each lender will want DETAILS on the whole "plan" from where the land is to what the builder's qualifications are, to your overall financial picture.