Hidden Construction Loan Requirements
Construction loans can be very complex and typically contain many hidden lender requirements that might be onerous to the owner and the builder. Therefore it is critical to ask as many questions as possible about your lender's policies and procedures regarding the details of the construction loan and the permanent loan.
The list below touches on several key points that can be deal breakers for you and your builder. Determine the answers to these questions and discuss your findings with the builder to assure the builder will work with the lender.
Borrower(s) are required to pay the entire portion of the down payment up front prior to any funds being disbursed from the loan proceeds. Know what your lender requires and so you can be prepared. If you give your down payment to the builder and the builder does not perform, you can be out the whole amount.
Borrower and builder must have a reasonable budget completed prior to finalizing the Construction/Permanent loan process and deciding on a loan amount. If all costs are not finalized, borrower must be aware of those items and the potential dollar amount those items might exceed the budget.
Change orders are to be paid by borrower at the time of the change order from the borrower’s own funds. In other words, if it’s not in the original budget, it will not be funded by lender. Be sure you have considered all the details in the budget or have funds available for changes.
Construction of the home is to commence within 30 days of initial closing. Make sure this is a realistic time frame for the builder.
All draws will be disbursed to either the builder or the owner as determined by the owner. In many cases the lender will only disburse funds to the owner. Builders do not like this requirement because it becomes a point of contention between the builder and the owner.
The final construction loan disbursement will be made jointly to the builder and the borrower. All draws will disbursed in accordance with the lender's draw schedule.
At the end of construction the construction loan will be modified (converted) to a permanent loan. Modification may carry additional fees. How much are those fees?
The interest rate on the permanent loan will not be locked until a certificate of occupancy for the home has been received. In periods of rising interest rates this can cost the borrower a higher interest rate. Be sure you understand the requirements for locking your permanent loan.
A 1% prepayment penalty will be imposed if the loan is repaid or refinanced prior to conversion. Be careful with this provision because you as the borrower want to have flexibility at the end of construction to get the best loan you can.
The loan amount cannot be increased or decreased during the term of the construction loan.
The loan will be re-underwritten if the construction takes more than 12 months. If your builder does not complete the house as scheduled this can be a problem especially if your employment or financial situation changes.
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