SPEC construction loans

September 4, 2014 by · Leave a Comment 

A SPEC construction loan is an interim construction loan only, and not the permanent financing because the exit strategy is to sell the property.  “SPEC” here is short for “speculating”, because the builder or investor is speculating that they can sell the property at a profit.   For this reason, the builder or investor is not expected to have debt ratios calculated with them carrying this loan.  Bank SPEC construction loans will require tax returns, but the analysis of those is generally limited to trying to determine if the guarantor(s) have enough income to meet their own obligations during construction and marketing time.

Liquid reserves remaining for the guarantor(s) after close of escrow are very important for any bank’s underwriting of SPEC construction loans.  Recent experience on similar projects in the same market area are also important to get the very best SPEC construction loan rates.  If the guarantor(s) are not the builder, but are investors, the general contractor’s experience doing similar recent builds can mitigate the investor’s lack of experience to some extent.

The banks that are doing SPEC construction are picking and choosing between many strong projects.  Generally SPEC construction loan rates for the premium deals, where the guarantor(s) and the GC are experienced, post closing liquid reserves are substantial, loan-to-cost and loan-to-value are low, credit is good, and the investors have outside income, are in the prime + 2% range.  If and when some or most of these elements are missing, the rates of more flexible SPEC lenders are in the mid-sevens.

Note that whereas the stated exit strategy is to sell the property, if SPEC construction lenders are paid off, they do not care how they were paid off.  If investors obtained permanent financing at the end of construction to keep the subject property as a rental, or even if they get themselves a “stated income” permanent loan to keep a property and occupy it, the SPEC lender is paid off and they’re gone.  It doesn’t matter how they are paid off.

Can we start construction, and then get a construction loan later?

January 21, 2011 by · Leave a Comment 

This is a bad idea for many reasons, but sometimes borrowers must start due to the permit process.  If this is the case, and you have to start grading, and maybe have to do the foundation, we would suggest a separate contract with the builder.  Contact a local office of First American, Fidelity or another big title company.  Tell them what you are doing.  Put grading, foundation, retaining walls, and utilities on a separate contract.  Obtain lien releases as instructed by the title company you’re going to use.  Finish work, pay everyone, and get lien releases signed.  File a notice of cessation of work, and expect to wait 30 to 60 days (check with title company) before getting a construction loan to build the house.  The best approach would be don’t go verticle if possible.

Certainly, it is better not to prestart at all.  Don’t even put up a fence or allow a porto-potty to be delivered. You create problems with potential mechanics liens and obtaining title insurance for the construction loan.  You will have even disqualified yourself from dealing with most construction lenders.  Some unwise borrowers have even begun construction, used up most of their reserves, charged up credit cards, and made themselves un-approvable because of credit scores and requirements for liquid reserves after close of escrow.

Do we have to sell our current home to qualify for a construction loan?

May 12, 2010 by · Leave a Comment 

Assuming there is no question of occupancy on the new home to be constructed, if you earn enough income to cover the PITI (principle, interest, taxes and insurance) on both homes, the answer is no.  Even if you can’t cover both payments with debt ratios that meet program guidelines, you may still qualify.  Before the mortgage crisis, the most flexible of construction lenders would ignore your current PITI, assuming in those boom times that you’d be able to sell your house.  These days, the best case scenario is being able to use 75% of market rents to offset or partially offset the PITI on your current house (the 25% not counted being for vacancies and expenses).  To use 75% of market rents though, the borrowers must prove at least 30% equity in their current house.  This could be done through an appraisal, or possibly a BPO (Broker Price Opinion Letter). This is a variation of the FNMA (Fannie Mae) “buy and bail” rule, requiring the same proof of 30% equity in one’s current home when future rents are used to help someone trade up and qualify for a new home. 

 The rule was put in place to help insure that borrowers didn’t buy a new home and bail on the one where they may have been “upside down”.  Since most banks underwrite to FNMA guidelines, even though the end loans are not go to end up at FNMA, this “build and bail” rule is pretty standard in today’s post mortgage meltdown era.  In its most restrictive form, it can also be applied to someone’s current rental properties which have little or no equity, even when these appear on tax returns showing stable rental income.  Fortunately there are still construction lenders who will use actual tax return income or losses on existing rental properties, therefore not requiring a construction loan borrower to carry the PITI on all their properties.

Can will build a log home or other kit home?

April 29, 2010 by · Leave a Comment 

The short answer is yes, you can get a construction loan to build a log home.  We’ve done them.  The problem is that the property has to be appraised, and it must be demonstrated that log home construction is common for the area.  Unfortunately, the way that is demonstrated is with typically with at least two of the recent comparable sales on the appraisal being log homes.  In areas where a log home might be built, sales are usually very slow these days, and this seems very unlikely.  Kit homes like a cedar home or an A-frame might be similar enough to typical construction in the area that no special “like comps” would be needed.  Try building an octagonal structure or one of the type of kit homes that has pod type connected rooms and you could likely anticipate insurmountable underwriting obstacles to obtaining a construction loan.

How do we qualify for a construction loan?

April 26, 2010 by · Leave a Comment 

There are two main elements of qualifying for a construction loan, the property and the borrowers themselves.  In regard to the property, it should be an owner occupied single family residence (some programs allow owner occupied duplexes), or a second home.  It should be clear from the circumstances that the borrowers intend to occupy the property.  Generally, there should be no indication that the borrowers might sell the property after construction is completed.  Banks do not want to give cheap construction money to someone doing a spec house.  Single close construction lenders want their construction loan program to be putting servicing in place over the long term.  If the property to be built appraises for less than the borrowers’ current residence, this might look like a “spec deal” and would be an area of concern.  If the property is not where the borrowers live and work now, and is not in what for them would be an obvious second home area, this might also get the construction lending underwriter thinking “spec deal”.

The property should be for a complete house that is neither an under, or over-improvement for the area.  You cannot get a construction loan to take you through the framing stage, thinking that you can do the finish work yourself over a period of time.  You cannot get a construction loan to build the guest house first, thinking you’ll move into it and build the main house later, the same way you could not get a conventional loan to buy, for example, a 3 car garage structure with 800 square feet of guest space above it.  This type of property is an under-improvement and cannot be appraised, and could only be sold to a cash buyer.  If you are the first in your market area to add or build square footage in excess of what is common, you may well find there are no comparable sales for the appraisal.  Existing structures on the property should not be commercial, such as a shop.   The property should be residential in nature and not agricultural.  There are title insurance issues if work has started, but construction loans to finish the work are still possible.

If you are a licensed general contractor who makes your living from job income (not capital gains generated from the sale of spec homes), it appears from the property value and location that the finished house will be owner occupied, and you can document sufficient tax return income working for your own company, owner builder is possible.  Having a GC license but working for someone else is generally not acceptable in this tough construction lending environment.  You’d have to be an “approvable” builder with past “happy homeowners”, vendor references, and a track record with your own company.  Generally, a fixed price contract with a builder is required.  Cost plus contracts and construction supervisor arrangements are rarely allowed in this market.  Construction lending is also back to where it was a decade ago in that the more restrictive of loan-to-cost or loan-to-value calculations is used.  You must have a certain amount of cash in the deal, or equity in the lot.  None of the single close construction lenders still in the business are lending off the appraised value without regard to cost. 

As borrowers, you must be able to fully document adequate income to qualify for the single close construction loan as well as your other obligations.  Your middle credit scores need to be at least 680, and 700 in some circumstances.  More than two years of self employment in the same business in the same market area is required in that at least two years must be reflected on tax returns.  You are not going to be able to blend in the income and liabilities of non-occupant co-borrowers in order to meet debt ratio requirements.  You must have verified reserves (about one half of which should be in non-retirement, liquid accounts) after close of escrow on the construction loan.  Reserve requirement minimums generally vary from 6 to even 12 or more months of the projected PITI (principle, interest, taxes and insurance) based on the locked permanent financing rate.  There can be limits on the number of financed properties, and if a minimum of 30% equity cannot be proven on current rentals or the rental of current principle residence, you may find that actual or market rents will not be used to offset those payments.

What is a single close construction loan?

April 19, 2010 by · Leave a Comment 

A single close construction loan, also known as a one time close construction loan, provides construction funding and is also the permanent financing.  This is in contrast to a more traditional interim construction loan which would require “take out” permanent financing to pay it off.  Single close construction loans have two basic structures.  Our construction loan programs 1, 2 and 3 are 30 year loans in which the first 12 months are the construction period, during which time the loan is interest only on the amount disbursed.  These loans begin to amortize after 12 months when the house is completed, and are 29 year amortization from that point, since 1 year of the 30 year loan was done as interest only.  For example,  a 5/1 ARM is fixed 5 years.  The first year is interest only, and the next 4 more years are the beginning of the 29 year amortization period.  This is the first type of single close construction loan where there is no note modification after construction is completed, and the construction rate is the same as the initial fixed period rate.

Our program #4 is an example of the note modification type single close construction loan.  In this program, the borrower is locked in on a 5/1 ARM which begins after the construction phase.  The construction phase of 12 to a maximum of 18 months is at a monthly adjustable rate.  Historically, these note modification type construction loans had a prime based initial construction phase with the rate being some margin above or below prime.  In our case, the construction phase is 4.5% above the 1 month LIBOR.  Like all bank construction loans, it is interest only on the amount disbursed during the construction period.  After the construction is done, the 5/1 ARM program begins.  Here you would have 5 years fixed at your locked note rate, and 30 year amortization.  A note modification is done when construction is complete.  This simply involves a notarized signature on a few documents to be recorded.  If someone had sold their current home, they could pay down the principle prior to modification, so the 30 year loan would have a lower payment.  Being a single close construction loan, just as with our programs 1, 2 and 3, the loan file is not redocumented, and the property is not re-appraised.