How do we qualify for a construction loan?

April 26, 2010 by  

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.

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