HomeNuts and Bolts of Construction Financing
by Gene Foley
The construction of a new home should be a fun and exciting experience.Knowing the basics to home buying will help to eliminate some stress duringthis process. Good planning for new construction just may be the differencebetween a good night's sleep and insomnia.
The first step is the selection of a general contractor. Most contractorshave property available to view for references. If this is not an option,ask the contractor for some names and phone numbers of previous clients.Most people are more than happy to talk about the workmanship in their newhome. Much like a new car, people are proud of their new purchase and willgive insight on the contractor.
Once the general contractor has been selected, the next step is to negotiatethe contract. Make sure all questions are answered before signing the agreement.Know what exactly is included in the contract. If there is a question aboutwhat is in the contract, make sure it is in writing.
Offering to do some work in exchange for a credit (i.e. painting) maybe more aggravation than the credit is worth. The time it takes a contractorto do the work, as opposed to the buyer, may be more cost efficient.
After the contract is negotiated, it is time to focus on the financingof the project. Some general contractors will finance the project themselves,so the buyer need only secure the end mortgage. When selecting this typeof mortgage, a concern could be the term of the rate lock. If the home isgoing to take four months to complete, then a normal 45-60 day rate lockwill not be enough. The borrower should investigate the rate lock optionsthat extend past the expected completion date. This allows for any delaysthat the builder may experience, such as bad weather.
Another common financing scenario is when the buyer supplies the constructionmoney. There are a few things borrowers should know in order to meet theirneeds. First, a low, permanent end loan rate is more important than a low,construction loan rate. The construction rate is only in effect for sixto twelve months while the permanent financing may be in effect for up to30 years. Second, construction permanent loans have only one closing. Thedocumentation signed at the closing may be modified for the permanent financingto take effect, or, in some cases, the loan starts amortizing at an agreedupon rate when the house is complete.
During construction, most banks charge interest only on the funds advanced.Therefore, monthly payments increase as the total money advanced increases.Once construction is complete, payments include principal and interest.
Funds are released during construction according to a schedule of disbursementsagreed upon prior to closing. Lenders usually release funds within a weekof a request, sometimes sooner. Funds are typically advanced for work completed,not for unfinished work or supplies on site. Once an inspection has beenmade, with a fee of $50-$75 per visit, funds are generally wired into theborrower's checking account, and, in turn, the borrower writes the checksto the builder. This gives the borrower final control over the disbursements.
Example
Loan Cost $ 35,000
Construction Cost $115,000
Total Acquisition Cost $150,000
Total Acquisition Cost $150,000
Down Payment $ 30,000
Loan Amount $120,000
The borrower will be putting a total of 20% down, which is $30,000. Atthe closing, the borrower put $7,000 down for the purchase of the land,so the lender released $28,000 for the balance of the land.
The total loan amount is $120,000. The lender has already released $28,000for the land, so the remaining calculations will be figured on the remainingbalance of $92,000.
Payment #1
The first payment is made to the general contractor in the amount of$14,000 for plans, permits, excavation, foundation and back fill.
Bank Allowances
Plans and Permits 3% $ 2,760.00
Foundation 9% $ 8,280.00
Total Disbursed 12% $ 11,040.00
Therefore, Payment #1 to the general contractor would consist of $11,040in loan proceeds, and the balance of $2,960 would be from the borrower funds.This is also how the remaining $23,000 in down payment would be calculated.Additional funds are disbursed according to a specified schedule of construction,and can be in as few as one or over five separate payments, or draws asthey are referred to in construction financing.
The first mortgage payment to the lender would consist of interest onlyon $39,040. This is the total of the land disbursement and the first disbursement.$28,000 + $11,040=$39,040.
Building your dream house has never been easier. Lenders with constructionlending experience are a great resource. Sitting down with a lender to reviewthe disbursement schedule and borrower obligations ahead of time will eliminateproblems before they occur.
Gene Foley is a mortgage originator for the Rockland Trust Companyand specializes in construction permanent loan programs. Telephone: (800)826-6102 extension 6684.