What is a construction Loan? Things you want to know.
Updated: Feb 19, 2020
In this video AES will explain the basic difference between a construction loan and a traditional home loan. We also discuss the importance of understanding the funding process for your construction loan.
Hello, and welcome to AES. My name is Paul Pablovich. This is our continuing video series on the process of building a house. In this particular video, we're going to be discussing lending, how to borrow money and what to expect and what to be prepared for when you're doing what's classified in the industry as a construction loan.
When I reference lender, it's mortgage lender, commercial lender, a combination of both. I'm not going to get into the minutia of what type of loan is best; it's not what this video is about. Professional Lenders will be able to educate you and you'll be able to make an intelligent decision because you're smart and you understand that you're in charge and you also realize that everyone works for you.
A construction loan is different. The main thing that makes a construction loan different is that there is no asset. I would like you to lend me $350,000 to build this house, there are certain things that the lender is going to want to verify. I'll try to keep this as simple as possible.
When you are buying a house, the lender will have the home appraised. That will tell your lender what the home is worth in the marketplace. So if you want to buy a $350,000 house and you picked out the house, it's there, it's for sale. You go to a lender, and a lender will check your credit. Then, they will send an appraiser out to determine the value of that existing structure. The appraiser will tell you that this house is worth $365,000. They will then close your loan, and lend you the money to buy that house.
A construction loan is different in that the home doesn't exist. It's not there. They will appraise what's going to be there. The lender will hand your project information to a real estate appraiser and the appraiser will tell them that if you build this house, it will be worth when finished, $360,000. The information you provide to your lender, the plans of the house, the explanation of the collateral are vitally important!
That's the process. That's what has to happen. So you can see why in our earlier conversations we've stressed the importance of a stamped architectural set of plans. We have stressed the importance of finding the right builder. We Have also recommended that you start the entire building process by talking to a lender about how much money you qualify for.
When you present this information to your lender and they get it appraised and they come back and they say, let's close this loan. At some point in this process, they're going to explain to you how you are going to gain access to your money. They will send you an email, hand you a piece of paper, verbally tell you how you. You're going to want to know. How are you going to give me access to the money that I am responsible for paying back to the bank?
This is important because somewhere in your building contract it should say, how the builder is going to get paid. It's usually called a draw schedule. It could be a schedule of values. It could be benchmark payments. it's usually I'm going to deliver the foundation of your dream home to you. At that point, you are going to be responsible for paying me X number of dollars. That's usually in the contract.
Let me remind you that you are in charge, that you have a tremendous amount of say in how you pay your builder. You guys will talk about this, you'll negotiate this and if it's a finance construction project, my advice is to find out from the financier how they plan on paying you! You can then discuss that process with your builder. So it's a question that you really need to ask and you need to ask it before you close on the loan.
So looking forward to letting you finance my construction project. Mr. lender, I'm so excited. I love the product you've offered me. I love the interest rate, It's fantastic. I just have a question. It's an important question for me. I need a detailed explanation of how you are going to deploy capital to me so I can pay my builder.
Questions you want to ask your lender:
· How Often?
· How Much?
When can I expect to be able to get money from you to pay my builder? Now that's important because if you haven't discussed what your builder wants with your financier, it can be a problem. Your builder may want money at this point in the project. Your lender may say, well, we don't give money at that point. We give money at this point in the project. So before we even get started, we have a problem. Once you close the loan, in my professional opinion, it's too late. You and the builder are stuck. There's no reason for that to happen.
You've done a tremendous amount of work to this point. You have chosen your builder, and now you're getting ready to enter into a transaction that is worth hundreds of thousands of dollars. This is a big deal!
Your lender's not going to conduct this transaction for free. They're going to profit from this transaction. Just like your builder is going to benefit from their contract with you. We need all of these pieces. The majority of us need this entire process to come together so we can move our family into our dream home. I'm just trying to prepare you for something you're going to want to know. When can I get money for my construction project?
What is the process by which I get the money? Do I send an email? Do I push a button? Do you call my builder? When can I get money and how do I go about doing that? So if I make a phone call or I send an email or my builder sends an email and says, Hey, I need money, and whatever that process is, you're going to want to know what that process entails? What does it consist of? How do I make this request?
After I make this request, how long does it take? Please ask your lender to be specific. How long does it take from the time I make my request till the time you make that amount of money available to me
Paul, I'm going to need $45,000 by the end of the week and you have confirmed with your lender that it's going to take a maximum of four days. Monday you push the button or pick up the phone or send the email or whatever the process is, the money will be available to you.
Friday comes, you pay your builder, everybody's happy.
If Friday comes, and you're checking your account and the money isn't there and Your builder is standing there saying, there's your framing. Can I please have my money based on the contract that you and I negotiated? It's important.
Your lender will map all of this out for you, but you will have to ask. You can do this. You got this.
Another question you're going to want to ask is how often can I pull money from my construction loan. How often can I conduct this transaction with my loan? Can I do it once a week? Can I do it once a month? Can I do it Tuesday to Thursday? Is there a limit? Can I do it as often as I want?
Depending on how your lender has structured this, they may tell you, you can only do a draw once a month. You can only do five draws. You can only do six draws and every draw or pay application after six is going to cost you $100, you're going to want to know that. Things will happen.
Now how much? How do you determine how much money you're going to give me per my request? Mr. Lender, it is important to me that I know the process by which you're going to fund my construction loan. In my experience, a simple, Oh, don't worry about it. We have an inspector, and he'll come out, and then we'll give you the money is not good enough.
There are so many moving parts to a construction project, and people are going to be looking at you because you are paying everyone, you're going to want to know the detailed process of how they are going to fund your construction loan. Your lender will tell you in as much detail as you need.
How are you going to fund me? Remember you're in charge and everyone works for you. You can tell them how you want this process to go because we haven't closed the loan yet. If it's within reason, they will accommodate you.
So if it feels like a painful process, it feels like a complicated process than it probably is and it shouldn't be. And you're going to want to get this straight before you close on your construction loan. Your lender will get it all worked out because you are an important client to them.
Let's see where we are now. We have a set of plans. We have a builder, we have a lender, and we know how the lender is going to give us the capital. We've had a say in that process. We've had a conversation about it. We understand that a construction loan is different than a traditional existing house loan, so we're in pretty good shape. Once we have all these boxes checked, we're going to close on this loan and we're going to start construction on your dream home. I'm excited for you. You've taken charge and you understand that everyone works for you.
I'll see you next time.