Construction Loan Guide 2022
At Ed Currie, we offer two different construction loan programs — our standard portfolio program and Fannie Mae’s Homestyle Program. While most loans utilize the portfolio program, there are instances where the Homestyle Program can be a better option or the only option. Because we know this can be a complicated process, we’ve prepared this document to help you explore your options. Of course, our team is happy to explain this in detail and answer any questions you may have!
Standard Construction Loan
Our portfolio program is a "one close", "construction to permanent" loan used to build or improve a single family or 2-unit home that will be your primary residence or vacation home. Investment properties, specs, or flips are not eligible. It's like a regular mortgage in every way except the payments are interest-only during construction.?
There is only one closing and it's before construction begins (not when the house is complete). Any down payment that is needed is required upfront. During construction, as long as you stay on budget, you will not need any additional funds.?
You do not need to own the property already. You can use the loan to acquire the property or land you will be building on or improving.?
Project Types Allowed:
Program Details
Payments:?
The payments on the portfolio program are interest-only on the balance that you owe. You will start out with a relatively small balance and as you draw funds to complete your home, the balance and interest-only payment will increase. Once your home is complete, the payment will switch to a principal and interest payment at the same rate. If you pay your loan down at the end of construction or don’t draw the full amount, the P&I payment will be based on the final loan balance.
Programs:?
Program options are similar to a regular loan. You have the option of a 30-year fixed or a long-term fixed rate ARM for 10, 7 or 5 years. The program and rate are locked in up front before you start construction and close and are the same both during construction and after construction is complete.
Appraised Value:?
This is the huge benefit of the construction loan. The appraised value is based on the completed project after completion of the improvements. There is only one appraisal that is done, and it's done prior to closing. Keep in mind this also means the appraiser needs the completed plans and budget for the project to do the appraisal. This can be challenging when using a construction loan to purchase a property and close within a typical contract close timeframe (eg 45-60 days). It's very important to note that the appraiser needs to have the final plans and budget at least 30 days prior to the expected closing date to allow time for the appraisal to be completed, reviewed, and signed off in underwriting.
Down Payment:?
The down payment you will need will depend on many factors including loan size, credit scores, project cost and appraised value. The land value may even matter at times. The down payment (or equity) can be as little as 10% down. If you have equity in the land or property you already own, that equity will count towards the minimum equity needed.
Your final down payment will be heavily impacted by the appraised value. That number will impact the maximum loan you can get. Depending on your project size, the max loan will generally be 90% to 80% of the appraised value.?
For a purchase, your down payment will be the difference of the purchase price plus the cost of construction, minus the max loan.?
For a property you already own, the max loan needs to cover the balance on any mortgage you have on your home plus the construction costs. If the max loan covers that amount, you can do your construction loan with NO down payment. If it doesn't, cover the mortgage payoff plus the construction costs, the difference is your down payment. It is possible to be cashless at closing on a construction loan if you already own the property and already have enough equity.?
If you give a deposit to the builder, this will be applied toward the down payment needed. If no down payment is needed on the loan, you may be able to be reimbursed with a check at closing for some or all of the deposits already made.?
Credit:?
Solid credit is important. The specific requirements will be different depending on your down payment and loan size. Minimum credit scores are generally 670-720 for this program.
Project Size:?
There is no minimum or maximum project size or loan request. However, we do require that borrowers hire a general contractor for their project. Self-builds are generally not allowed but there are limited exceptions to this such as a full-time builder building their own primary residence.?
Your Builder:?
Your builder, or general contractor, is a very important decision. The person or company you choose to build with will dictate how successful your project will be and what type of experience you will have. The builder selection is all yours. Your builder will need to agree to our policies.
We can, however, pass along the name of a builder or two that may be a good fit for you and your project based on the type and location. Let us know if you would like us to do so.
Permits:?
These are not required to close but you must have them by the time you take your first draw after closing.
Current Loans:?
If you already own the property and have a mortgage on it, the construction loan will roll your current loan into the construction loan.?
Construction Costs:?
You can include additional costs on top of the builder's contract price. "Soft costs" or items outside of the builder's contract can generally be included in the total construction budget. You can even add a contingency to the budget to cover any overruns. For items outside the builder's contract, you may need to provide a separate bid.?
Closing Costs:?
Specific costs for you will vary depending on a lot of factors. Is it a purchase? Do you own the property already? The title company and project size will also have a big impact. Broadly the closing costs are pretty similar to a regular loan with the addition of inspection fees. Every time your builder requests a draw, an inspector will check to see if the work is done. So check with your potential builder on how many draws they will take on your project. This will help in understanding your closing costs. Additionally, you also have the option to structure the loan in a way where you pay no closing costs (for a higher rate).
Draw Period:?
We set up the draw period for 12 months regardless of the size of the project. If you need less time, your payments will change from interest-only to principal and interest when your project is complete. If you need more time, we can generally automatically extend it for two months. Additional extensions are on a case-by-case basis. At no time will you have to pay a fee to extend (many lenders do charge fees for this). This could be very costly elsewhere and can happen often on larger projects.?
Once the construction phase is over and the final draw is taken, the only change to the loan is from interest-only payments to a principal and interest payment at the same rate. We do not require that the loan be paid off or refinanced. However, once the construction project is complete, we will do a courtesy review of your current program to see if better options are available. If they are, we can simply modify the loan to a different rate or program (eg ARM to fixed) without going through the refinance process. That means no financials, no appraisal, and no closing. We simply lock the rate and send you a one-page modification agreement. There is a flat fee depending on the size of the loan but is much less than the closing costs associated with a full refinance.
Fannie Mae Homestyle Rehab Program
We also offer Fannie Mae’s Homestyle Program. The Homestyle Program allows for a smaller down payment or equity as well as lower credit scores. The downside to the program compared to our own program is the rates tend to be a little higher and you pay full principal and interest from day 1 versus interest-only during the construction phase and P&I when the construction is complete.?
Project Types Allowed:
Project Types NOT Allowed:
Program Details?
Payments:?
The Fannie Mae Homestyle program is similar to a regular refinance in that when you close, the balance on the loan will be the full amount and your payment will be the full principal and interest payment on the total loan amount (even though you haven’t yet drawn the full amount).
Programs:?
For Fannie Mae’s Homestyle program, the only option is a 30-year fixed.
Appraised Value:?
Just like our portfolio program, the appraised value is based on the completed project after completion of the improvements.?
Down Payment:?
The down payment can be less on the Homestyle Program with as little as 5% down or equity. If you have equity in the land or property you already own, that equity will count towards the minimum equity needed. A second home, investment property or 2-4 unit property will have higher equity requirements.
For a property you already own, the max loan needs to cover the mortgage payoff(s) plus the construction costs. If the max loan covers that amount, you can do your construction loan with NO down payment. If it doesn't cover mortgage payoff(s) plus the construction costs, that is your down payment. It is possible to be cashless at closing on a construction loan for the property you already own the property and already have equity.?
If you give a deposit to the builder. this will be applied toward the down payment needed. If no down payment is needed, you may be able to be reimbursed with a check at closing for some or all of the deposits already made.?
Credit:?
The Homestyle Program allows for credit scores as low as 620. However, the lower the score, the higher the rate. Best rates are achieved at a score of 740+.
Project Size:?
There is no minimum or maximum project size or loan request. However, we do require that borrowers hire a general contractor for their project. Self-builds are generally not allowed but there are limited exceptions to this such as a full-time builder building their own primary residence.?
Your Builder:?
Your builder, or general contractor, is a very important decision. The person or company you choose to build with will dictate how successful your project will be and what type of experience you will have. The builder selection is all yours. We will do some background on them but there is no formal approval process that your builder must go through. Since we work with so many builders (good and bad) if you would like a name or two of companies that clients have had good experiences with, let us know. There's a very good chance they work in your community.?
Permits:?
These are not required to close but you must have them by the time you take your first draw after closing.
Current Loans:?
If you already own the property and have a mortgage on it, the construction loan will roll your current loan into the construction loan.?
Construction Costs:?
You can include additional costs on top of the builder's contract price. "Soft costs" or items outside of the builder's contract can generally be included in the total construction budget. You can even add a contingency to the budget to cover any overruns. For items outside the builder's contract, you may need to provide a separate bid.?
Closing Costs:?
Specific costs for you will vary depending on a lot of factors. Is it a purchase? Do you own the property already? The title company and project size will also have a big impact. Broadly the closing costs are pretty similar to a regular loan with the addition of inspection fees. Every time your builder requests a draw, an inspector will check to see if the work is done. So check with your potential builder on how many draws they will take on your project. This will help in understanding your closing costs. Additionally, you also have the option to structure the loan in a way where you pay no closing costs (for a higher rate).
The Loan Process
Application:?
We can start the application with an estimated budget amount. We do not need final plans and budget to start the application although we cannot order an appraisal until those items are available.?
Documentation:?
We’ll generally request just income items upfront at the application to allow us to review the income along with credit and liabilities. This should provide us with a relatively clear picture of the viability of the application request.
For loan approval, we will need additional items. As much as we try to limit what we ask you for, the regulators who monitor banks require that we fully verify your "ability to repay" your loan. Even if we think there's no chance you would default on your mortgage, we have to ask you for a lot of things that seem to be pointless items to fully document your file. We can guarantee you that we will never ask for anything that we won't need to ensure we get the loan you want to be approved.?
Another reason we sometimes have to ask you for more stuff is that the initial documents you provide us contain something (like a large deposit) that we have to further document.?
The more complex your financials are will also impact what we will need. If you own a business or businesses (in part or in whole), or if you own investment property, we will need to document those in different ways.?
Generally speaking, we need to document your income, your assets, your liabilities, and the details of your construction project.
Processing:?
Once we have the items needed, we will send the loan off to underwriting for a loan decision.?
Conditional Loan Approval:?
In most cases, the initial loan approval will come back before the appraisal. So, we will receive a conditional loan approval subject to the appraisal. We will generally not submit the construction items with the underwriting package in case you want to make some changes once the appraisal is back.?
Order Appraisal:?
Once the plans and budget are complete, we can order the appraisal. Plans can come in different forms depending on the project. A well-defined budget and specifications will provide the appraiser with the detail needed to complete the appraisal.?
Appraisal Received:?
The appraisal will generally take 2-3 weeks. The value will dictate the final loan options including max loan amount. Clients may also make small changes to the budget as well by adding a contingency or making small reductions in the budget to reduce the cash to close needed. While it is OK to make changes once the appraisal comes back. any changes need to be reviewed by the appraiser. Large changes to the budget or project scope may require a new appraisal.?
Final Loan Amount:?
Now that the appraisal is back, and any revisions have been made to the budget. we can make any final changes to the loan amount.?
Firm Up Loan Program and Lock:?
If we have not done so already, we will make the final loan program selection and lock the rate.?
Final Items and Get Ready to Close:?
In most cases. once the appraisal is in, we need to just send in the appraisal and contract you have with your builder. In some cases, we may still have some other items or conditions that need to be satisfied.?
Close:?
Once we have final conditions, title and homeowner's insurance we can schedule closing.
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Timing:?
Timing for the construction loan process often depends on when the plans, specs, and budget is available for the appraiser. The general guidance is that once we receive these items to be able to order the appraisal, we should be able to close in 30 days or less.?
This timing is very important to understand for construction loans in which you will purchase the property at the same time. Since there is only one closing on the loan and only one appraisal on the loan, the plans and budget need to be completed at least 30 days prior to closing. This can be difficult to get done in the typical 45-60 day timeframe. In many cases, people will purchase the property first and close on the construction loan a few months later.
Loan Tip
You may want to consider putting the minimum down that is required for the size of the project. Often times there are cost overruns during the construction phase, and you will be required to pay for those costs. If you hold on to as much of your cash as possible, you can be prepared for any expected or unexpected cost overruns. You can always pay down the loan at the end of the project before the permanent phase kicks in to keep the loan payment down. Also remember, you are only paying interest on the outstanding loan balance during the construction phase, so funds not yet used do not accrue interest to be paid. Funds not used by the end of construction will reduce your final principal loan balance going forward. This strategy does not apply to Homestyle loans.
The Appraisal Process
The appraisal process is a little different than a "normal loan". Because the appraiser is appraising the home based on the plans and specs, it's important that the appraiser has the best and most complete information available to ensure the best possible appraisal.?
To ensure the best possible appraisal, the appraiser should be provided with:?
Floor Plans and Elevations:?
The appraiser needs to understand what the home will look like after construction. The plans and elevations allow the appraiser to understand how many rooms, bedrooms, and baths the home will contain. It will allow him or her to understand what the completed project will look like so he or she can compile the best comparable home sales for the appraisal. If the project includes just rehabbing the existing floor plan and there will be no change to the structure, floor plans are not required.?
Specifications:?
Specs tell the appraiser what will be included in the project, the extent of the work and the quality of the materials that will be included.?
Budget:?
Although the appraiser will ultimately be rendering his or her opinion of value based on the details of the construction project and similar comparable home sales, having a budget available for the appraiser is required and also gives him or her additional insight into the extent of the project and quality of construction.
A Good Conversation?
A lot has changed in the mortgage world over the past several years. One big change has been how appraisals are ordered and the inability of a loan officer or processor to speak directly with an appraiser. This indirect communication with the appraiser can sometimes leave some of the details of the construction project left out even with the best of efforts. To ensure that the appraiser understands the construction project, it's vitally important that the primary contact for the appraiser be able to explain the project. The best contact is the contractor or the homeowner.
Q: What happens if the appraisal comes in lower than anticipated?
A: If the appraisal comes in lower there are a number of easy and not-so-easy options.
How the home design affects the appraised value?
The design of the new home or home remodel will be based on what is most important for the client. However, it is best to know and understand the things that will help you get the best possible appraised value. While some things may be very important to you, they may add very little value to the appraised value. There is nothing wrong with this, of course, as long you understand that they may be required to put down a larger down payment.?
First and foremost, it is very important the client do as much due diligence upfront on what the potential appraised value may be on their home after completion. Sources like Redfin, Zillow, and others have a lot of data on homes sold that should give a pretty good idea of the range of the appraised value.?
The appraiser should be selecting comparable homes that are newly built or recently rehabbed like the subject property. By doing this, there should be few adjustments for differences in the condition of the comparable.?
Below are the items, when compared with comparable sales, the appraiser will make the biggest adjustments for.?
Biggest Adjustments?
Location:?
In most cases, the location of the home has already been selected. So there's not much that can be done to change the location. However, the subject property’s location relative to the comps chosen for the appraisal will have an impact. Factors relating to how busy the street is to what the property backs up to all have an impact.?
The size of the box:?
How big is the home? How many square feet (or gross living area as it is called) does it contain? The gross living area (or GLA) of the home is the most important determining factor of value. The appraiser will start with the size of the home and look for similar size homes to develop an appraised value. Also, the GLA is calculated using "above grade" square footage or above ground. Basement square footage is not counted in the GLA for the home but is counted toward the overall value. This can make it difficult for ranch homes with finished lower levels or split-level homes to get the desired appraised value since the square footage below grade is not calculated in the total home GLA.?
Beds and Baths:?
Of the two of these, bathrooms have a bigger impact on value. An additional bathroom will add more value than an additional bedroom. In fact, appraisers in most cases will not add value for the home having one more bedroom than a comparable home.
Smallest Adjustments:?
Quality of materials: Appraisers very rarely have personally inspected the comparable homes that they use in an appraisal report. They, of course, cannot ask the owner of a comparable to walk through their home. Because of this, they need to rely on descriptions in an MLS listing or a conversation with an agent. They are able to understand the general quality of materials used in a new build or rehab, but not enough to make adjustments for higher-end materials.?
Exterior Items:?
Patios, porches, and decks will have a positive impact on value.?
Finished Basement:?
The square footage in a basement is not counted in the overall square footage of the home. However, if the home contains a finished basement. there will be a positive value adjustment compared to a home that does not. Additionally, having bedrooms and bathrooms will add value as well.?
Other items that will have small adjustments:
? Size of garage
? Fireplaces
Little if any adjustments:
? Energy efficiency
? Maintenance items like fresh paint and a new roof
The Construction Budget?
The construction budget is important for a few reasons. It's important for the loan process to calculate the cost of the construction project. It's important for the appraiser so he or she can understand the cost of the project. And it's also very important because it will drive how draws are handled during the construction phase of the project. So understanding how the funds are distributed during the draw process is critically important when constructing the budget.?
How the Budget is Used During Construction?
The budget is used during construction as a guide to how much gets paid out for a particular line item. It's important to understand that the construction loan is not paid out based on the entire loan amount or construction budget. but individually based on each line item.?
For example, if the construction budget is $400,000 the client can't simply take draws on the project for any amount on any item until the $400,000 runs out. Draws get paid out for a specific line item up to the amount that it was budgeted for. So if the $400,000 construction budget has $20,000 budgeted for cabinets and the final costs comes in at $21,000, the client will be responsible for coming up with the additional $1,000 at the time the draw is taken for the $20,000. This is the case even if the client has not used the entire $400,000 construction budget.
Can I Change Totals Within Line Items?
Borrowing from other line items is allowed as long as the line item being borrowed from is closed out. Using the cabinet example above, if the cabinets come in at $19,000, that line item can be closed out and the $1,000 can be pushed forward into another line item.
Why Are Draws Done This Way?
The reason draws are done based on individual line items rather than the total amount of the construction budget is to safeguard against a situation where the client runs out of construction funds before the house is complete.
How to Put Together a Budget?
Knowing that the draws are done based on individual line items. it's important to put together the budget with care to avoid unexpectedly needing additional funds during the construction phase.?
One of the ways the client can minimize needing additional funds during the construction phase (aside from staying within budget) is to build in a contingency line item (sometimes called an "upgrade allowance" or "design fee") of up to 10% of the budget. In instances where the client goes over budget on a line item, funds can be pulled from the contingency line item.?
If there are funds left in the budget at the end of the project, they can be used for other items like landscaping or can simply reduce the final loan amount.?
The appraisal may also have an impact on the final budget prior to closing. If you get an appraisal with the full anticipated value, you will be able to build in the 10% contingency line item. If the appraisal comes in less than expected or hoped for, cutting back the contingency line is recommended if it affects the cash needed for closing.
Budget Tip
A contingency reserve is a budgeted amount of money above and beyond the contracted price with the contractor that is set aside for any unforeseen cost overruns. Although our construction loan programs do not specifically require a contingency reserve, it is highly recommended to avoid or minimize funds that may be needed during the construction phase. Keep in mind, the client only pays on funds used and not the entire approved loan (this does not apply to the HomeStyle program).
Types of Contracts?
We have different requirements depending on the type of contract you have with the client.?
The Flat Fee or Lump Sum Contract:?
If the type of contract you have is a flat fee or lump sum or stipulated value contract, we will need a signed contract with the client. We will also need a General Contractor's Sworn Statement for the appraiser and underwriting. This does not need to be signed by the client. If there is a plan to take a draw for a deposit at the time of closing that will need to be reflected on the sworn statement.?
The Cost-Plus Contract:?
If the type of contract you have is a cost-plus contract, we will need a signed contract with the client as well as a signed General Contractor's Sworn Statement from the builder and the client prior to closing. If there is a plan to take a draw for a deposit at the time of closing that will need to be reflected on the sworn statement.?
With this type of contract, we tend to see more line item changes during the construction phase and thus the higher chance of funds needed from the homeowner during the construction phase. It is very important that the budget provided for the loan is as firm as it can be.?
Types of Insurance?
Just like any loan, proof of adequate homeowner's insurance is required. For a construction loan, additional insurance may be required depending on your construction type and the current insurance policy.?
The type of insurance that is needed depends on the project:?
If the client will be building a whole, new home with raw land or tear down an existing home, they will need to get builder's risk insurance.?
If the client is doing an addition or internal rehab on a property (whether the client will be purchasing a property or already owns the property) a standard policy with a construction endorsement that covers materials on-site against hazard and theft will be needed. Some insurance carriers cover these types of projects in their standard homeowner's coverage, so you'll want to check with your agent and let them know what you're doing to the home to confirm you are covered.
Deposits at Closing?
At closing, you can provide your builder a deposit or down payment. Any deposit of down payment should be spelled out in the contract. A draw of up to 10% is generally acceptable. It is best to do that at closing and not right after closing as that could be delayed until the first draw takes place. Any deposit at closing must be allocated for items completed at the time of the first draw after closing.?
The Construction Phase
The construction phase starts at closing. It's at that time the first disbursement occurs on the loan in most cases. Any additional funds needed in excess of any funds you will contribute will be drawn from the loan.?
The Draw Process:?
Our draws go through a title company for work completed or items installed. Funds will not be disbursed to pay for future work or working capital. Our goal is to assist and guide you through the draw process so you are able to receive the funds as quickly as possible so you can continue with the project and pay your subcontractors.?
There can be slight variations of every draw process depending on the contractor and title company but generally, it's the following:
Initiate - Verify - Disburse Funds
Initiate:
Verify:
Disburse Funds:
Deposits During The Construction Phase?
Deposits for custom items during the construction phase are generally approved for 50% with the rest drawn at the time installation is verified through the inspection. The typical items where deposits are allowed are with custom items like cabinets and countertops where the vendor requires a deposit to construct the item.?
Changes to Budget After Closing?
Any increases in the cost of individual items will need to be covered by you dollar for dollar at the time the cost is incurred. Taking from another budgeted item that has not been closed out is not acceptable. If the cost for something comes under, you can push that savings forward and use it later in the project.?
The Permanent Phase?
Once your home is complete and you take your final draw, the loan changes over to the permanent phase. The rate and program stay the same as when you locked in upfront. Depending on when in the month you take the final draw, the permanent loan will start between 30-60 days from that date. For our Portfolio Loans, the permanent loan will change the payment from interest-only to principal and interest at the same interest rate at this time.?
It is at this time you will want to do a quick review of your loan and see if better rate options are available.?
While there are checks and balances in place with the title company and inspector, your money is your responsibility. On every draw, be sure you understand what money is being drawn and what it is being drawn from. If you don't understand it, contact your builder to do so. The draw request comes from your builder.
Ed Currie And His Team
Working with clients who are building a new home or doing major rehab is one of Ed Currie's specialties. With over $3 billion in lifetime closed business Ed is the #1 new construction loan officer in the United States, and on average closes 20-30 construction loans each month! That means Ed and everyone on Ed’s team is extremely proficient in the construction loan process from application to closing. If at any time you have any questions, feel free to call us at 847-214-2404, or complete our contact form on our website. For more tips and our latest updates, check us out on Facebook, Twitter, LinkedIn or Pinterest!