LOAN PROGRAM

A construction loan is a mortgage loan that is used to help finance a construction project of various types. The loan and appraisal is based on the completed project.

If you are purchasing a property that you will do the construction work on, the loan will be based on the entire project of land cost plus construction cost as well as the appraisal.

If you will be doing the work on a property you already own, the loan will be based on the completed project. The original cost of the property may or may not be a factor. Like a refinance, the construction loan will pay off any mortgage(s) you have on your home.

The loan is a permanent mortgage with a 30 year term (sometimes referred to as a “construction-perm” loan). There is one closing that takes place before construction begins. If you are purchasing the property, the closing would take place at the time you close on the land. There is no second closing once the project is complete.

Any down payment is required at the closing which is prior to construction beginning. As long as you stay within budget, all funds for the construction project will be pulled from the loan during the construction phase. If your budget increases during construction, you may have to make up the difference as items get paid out.

The down payment required (or equity if you already own the property) can vary widely depending on a few factors such as credit score and loan size. Smaller loans with good credit scores allow as little as 5% down (or equity) with the down payment increasing as the loan size increases and credit scores drop.

The payments on a construction loan are interest only during the construction phase based on the balance that you owe. The balance when you close will be relatively low and then as draws are taken on the loan for work complete, the balance on the loan will increase. So the interest only payment will start out relatively low as well and increase as the loan balance increases.

Once construction is complete, the loan moves into the permanent phase and the payment changes from interest only to principal and interest at the same interest rate. There is no second closing and the loan does not balloon or come due. You simply start making regular principal and interest payments.

LOAN PROCESS

The loan process for a construction loan is not much different than a “regular loan”. There are a few additional items that are needed that relate to the construction project and appraisal, but the process and qualifications are very similar. If you qualify for a non-construction loan, you should qualify for a construction loan for a similar amount.

Most clients will get started on the loan process when the plans and budget are nearing completion. This way, they can get the loan approval out of the way. Once the plans and budget are complete, the appraisal can be ordered. The appraisal for a new construction loan does take longer to complete – 15 to 20 days is a typical timeframe. Once the appraisal comes back, the client will most likely have a conditional loan approval subject to the appraisal and a few minor items. Once the appraisal and any other conditions get signed off, closing can be scheduled.

Getting Started

An initial call with the loan officer is the first step. During that conversation, you will discuss the basics of the loan program and what it means for your specific project. At the end of the call you should have a good understanding of how the program works, how much money you would potentially need for closing, what your payments would look like (both during and after the construction phase), and what the next steps would be.

Application

The need for a face to face application is no longer needed and very rarely done. Virtually all loan applications are done via phone, email, and fax. Once you have decided to move forward with the application and have sent in the initial items an additional conversation will firm up the loan structure, program type, and interest rate. In many cases, the final loan amount and structure of the loan is not finalized until the appraisal comes back since that may have an impact on the loan.

Documentation

Documentation requirements vary widely depending on how you earn income and your specific loan request. Initially, just income documentation and a complete mortgage worksheet will be needed to start the loan process. Once the loan is started, additional items will be requested based on your specific financial situation. The following is a list of the types of supporting items that may be needed:

• Documentation to support income
• Documentation to support assets needed for down payment and reserves if needed
• Documentation to support monthly liabilities
• Construction plans and specs when available
• Detailed construction budget when available
• Signed construction contract

Timing

Timing for the construction loan process is highly dependent on when the plans and budget are available. Because the appraisal is based on the completed project, the appraiser needs the plans and budget to complete it.

There are two separate processes that occur during the construction loan process; loan approval based on income, assets, and credit and the appraisal process. Loan approval can take between two days and two weeks with normal loan volume and the appraisal generally takes 15-20 days from the point the appraisal is ordered. Those two separate processes can take place simultaneously. So if the plans and budget are complete at the time the client applies, a closing in 30 days or less is possible.

If you are purchasing a property that you are doing a construction project on, you want to give yourself extra time in the property contract to get approval and close. It will generally take longer to get the plans done and the budget developed than you think. Sometimes, if able, it is best to acquire the property first and close on the construction loan at a later date.

Closing

Once your loan is approved and any and all conditions have been cleared you can close your loan. You will need homeowner’s insurance. The insurance policy will vary depending on your project but may be a standard policy with construction coverage or a separate builder’s risk policy.

If you and your builder have agreed upon a deposit, a deposit of up to 10% of the construction budget can be given at closing.

CONSTRUCTION PHASE

The construction phase begins after you close on your loan. It’s at the point your construction loan is in place and you can start drawing on it to complete your project. You will generally have 12-18 months to complete the project. That timeframe can be extended by exception at no cost.

The most important thing to remember during the construction phase is that the loan will get paid out based on the original budget – line by line. If there are any increases in each line item, you will have to cover the increased cost dollar for dollar. This keeps the loan “in balance” with available funds to complete the project successfully.

The Draw Process

During the construction phase your builder will request draws for work completed or items installed. Funds will not be disbursed to pay for future work or working capital. A number of things occur during this process. Ideally, if the process is smooth the only item you will be aware of is signing your owner’s statement to authorize the draw once the due diligence has been completed. All draws go through the title company.

There can be slight variations of every draw process depending on the builder and title company, but generally it’s the following:

Initiate

• The builder sends a sworn statement and other items to the title company and the bank to initiate the draw request.
• Bank orders an inspection to verify the items that are being requested to be paid on have been completed

Verify

• Title company reviews the builder’s sworn statement for accuracy and completeness as well as other items needed from the builder such as lien waivers
• Bank reviews the builder’s sworn statement for accuracy completeness, and budget changes. Any potential changes to the budget or line item shifting may require the client to send funds to the title company before the draw will take place.
• Inspection takes place to verify that all items that are being requested to be paid have been completed or completed at the percentage requested

Request Funds

• Builder’s completed items are sent to Associated Bank’s servicing department from the title company.
• Homeowner signs an owner’s statement authorizing the draw which is sent to title company and then forwarded to Associated Bank

Disburse Funds

• With completed paperwork and inspection report showing work complete, Associated bank wires funds to title company
• Title company disburses funds to builder and sub-contractors.
• Note: It is ultimately the homeowner’s responsibility to make sure the money that is being drawn from the loan and paid to the builder and contractors is accurate and reflects work complete. The homeowner has final control over the funds being drawn by signing (or not signing) the owner’s statement. Make sure you understand what the funds being drawn are being used for and that the amount is reflective of the work complete.

The Final Draw

The final draw is, of course, the last draw you take on your loan during the construction phase. It’s at this point the inspector will state your home is complete per the plans and specs on the final inspection.

Once the final draw is taken and the final inspection is complete, your loan changes over to the permanent loan. The permanent loan payment will be principal and interest based on the final balance of the construction loan amortized over the remaining term. In most cases your final loan balance will be the amount of the construction loan. If the budget came in lower than initially projected or the client makes a principal reduction before the loan converts to the permanent phase, the P&I payment will be based on that lower amount and not the higher construction loan amount.