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Construction Loans - Construction Loans: Questions and Answers It will seem that construction activity is still fairly high based upon the number of calls that I obtain from people regarding construction loans. There are a lot of calls from people just getting started, as well as from a number of seasoned “construction veterans.” In a large number of those calls, I hear some common questions. So I thought that I’d answer a few of them here. Q: How do construction loans work? A: In general, just like every other loan. You sign loan documents including dollars is funded into escrow. In the case of a construction loan, only a portion pertaining to the total loan is released. The balance is released either in preset “stages” or as workers complete portions pertaining to the project according to a budget. The former is called a “draw” system including the latter is called a “voucher” system. Q: How are the payments calculated including who makes them?” A: Commercial loans have the added security of a particular income producing property providing the funds to pay the loan payments. For residential loans, it’s the borrower’s income. at the time a property is being built, there is absolutely no secondary source of repayment so the burden of payment will normally fall to the borrower. But lenders didn’t need borrowers to use up all of their funds in case something went wrong with the project, so they created “interest reserves.” the is a chunk of dollars set aside in the loan to do nothing but make the loan payments during the construction process. The payment is based upon how much dollars has actually been used or “drawn” at the time the payment is due. the is not the case for private dollars lenders. They calculate interest on the entire amount pertaining to the loan from the initial funding date. Q: What’s a contingency reserve? A: the is another chunk of dollars set aside in the loan to protect you against cost overruns. Since it might take a year or more to complete a project, the prices used to estimate the construction budget become less accurate as time marches on. The contingency reserve is released a little bit at a time during the construction process to cover inevitable price increases. Q: How do you calculate the maximum construction loan? A: The maximum construction loan is based upon many factors: Property type, stabilized value at completion, total costs, including equity invested to name a few pertaining to the key concerns. For any given property type, there is usually a maximum “loan to costs” including a maximum “loan to value.” The key is this: The largest permanent loan for which the property might qualify, assuming it is built including fully occupied or valued, could limit the construction loan. the is because the construction lender wants to be paid off at the end of construction including the way to do that is with a permanent loan. the does not mean that if the permanent loan exceeds the total costs pertaining to the project that you might obtain 100% construction financing. Just regarding every lender is going to look for 10% to 20% pertaining to the total costs to be funded by equity or cash from the borrower. I hope that these few examples clarify some pertaining to the questions that you might have concerning construction lending. I’ll cover more here in the future. If you should have a question that wasn’t covered, email me at your convenience including I’ll do my best to give you a complete answer.
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