Understanding Construction Lender Packages for Custom Homes
Today I want to talk about what a lender needs if you’re getting ready to build a custom home. Obtaining a loan to build a custom home is completely different than buying an existing resale home. On a resale home, you give your financials to the bank, they look at your financial status, they do an appraisal on the property, they do several things. When everything looks good, the bank starts preparing that loan to closing, and eventually you buy the property.
An Approved Builder
A construction loan requires a longer process on the front end. The builder that you’re working with must qualify with the lending bank. Check with the lender and see if your builder is approved with them. If they are approved, no further action may be required. If the builder is not pre approved, you need to request a building packet from your lender. The builder will fill out that building packet and submit it to the lender. The lender will make sure the builder is reputable, and then approve the builder to work with that bank. So, make sure the builder that you choose has enough history that your lender will approve.
Once you have an approved builder, you must gather a group of items: a building agreement, a book or form that identifies the specifications, a cost breakdown or itemized list of costs, and a set of plans. The lender needs to know what the price is, what type of finishes are going into the build, and what the exact costs are for the project.
After you collect these items, the lender can determine what the appraised value will be once the construction is complete. The appraisal process considers the value of vacant land, the potential value of this home if it existed today, and the values of comparable homes/properties that already exist. If the loan-to-values work out, the lender qualifies you as a borrower and award you that construction loan.
The Building Agreement
The Building Agreement identifies who the contractor is and who the owner is. It gives a description of the work, the project location, size of the house, and a timeframe on when the project will complete. The Building Agreement also contains a section for change orders and what happens if change orders occur, such as a markup rate or margin. Typically, a bank bases the loan draw schedule off the percentage of completed work. This draw schedule is managed through a fund control system. Those are the basic components within a building agreement.
The Specifications Book
The Specification Book is an addendum to the building agreement. Here at Freeman’s Construction, we provide a spec book that takes up 40 to 60 pages, depending on the project. This addendum specifies the details for your build. Although the spec book is very detailed, the bank doesn’t need that much detail to move forward. The bank often has its own specifications sheet that only fills out a couple pages. They want an idea regarding the finish level of the home, which could be average, luxury, etc. This helps the appraiser identify a value to complete his appraisal.
The building agreement rarely includes the cost breakdown, but it is necessary for the bank to make sure that all the costs are accounted for, so they can determine what they are comfortable moving forward with. Inside the cost breakdown, a contingency is included, often between 2% and 5%. The bank wants to make sure that something exists. Many banks require approximately 5% contingency, but some don’t care and trust that which the builder determines. They typically want to ensure that a small margin is available to take care of any unknowns.
The cost breakdown identifies specific amounts of the project line by line. This helps the bank disperse money according to construction progress. For example, when the foundation is 100% complete, which could cost $40,000, the cost breakdown discloses that amount, which allows the bank to release that $40,000.
Another important item is the building plans. A set of floor plans and elevations are sufficient to help start the process on obtaining the construction loan.
Banks do not require issued permits to fund a loan and will typically give you a time frame to build in. Some banks allow nine to 12 months, and often extend that time frame to 18 months. They occasionally charge an extension fee, but the loan usually closes if the issued permit and start of construction is close enough to allow the house to finish before the loan period runs its course.
Construction Loan Extensions
Say the loan period is 12 months when you receive the loan, and the County issues the permit 2 months later. An eight month build that starts two months after receiving the loan, only takes ten months and falls within the 12-month construction loan lifespan. If an extension is necessary, there’s typically a percentage cost based on the loan amount. That amount may be half-a-point to extend a month or two months. Umpqua bank currently has a pretty good deal that allows up to a six-month extension for just a few hundred dollars. Each lender is a little bit different.
Those are the basics for getting together a lender package. I hope that gives some good insight. If you have more questions, feel free to visit our website at TFGonline.com. We have a bunch of information and resources, which can be found on our resources tab. Thanks for your time today and have a great rest of your day.