The loan process is inevitable for many people that want a custom house, since not all of them have the resources to build one. Few are the ones who really dare to adventure in this direction.
It is the entire construction process that scares them. Extending on a rather long period of time, it necessitates as much competency and planning as possible so that the results can be truly satisfactory. However, the core of this endeavor relies on the loan process because this element enables the launch of the actual building act.
Things to Do before the Loan Process
You don’t want to start too early with banks because you might end up with excessive redundant expenses, whereas waiting too much can overly delay the start of the build. Hence, the right timing to cover the underlying stages represents the key to success. But before engaging in the phase of lending money for your custom house, you need to complete several other steps that would serve as a sort of premises for your bank application. These preliminaries or preparations consist of:
- purchasing a lot for the building project;
- putting personal finance in order;
- having the construction plans finished and submitted to the building department.
I. Selling the Current Residence
After these steps have been covered, you are good to head towards the money-borrowing part. Among the first concerns that arise when approaching this stage is the one regarding when you ought to sell your existing house. The good news is that you don’t have to do it before you afford the financing of the new residence. The cost of your current dwelling is not calculated at the assessment of your construction loan qualifications. However, you need to submit a letter expressing your intention to sell or rent it when the new house is finished. Thus, you avoid incurring expenses of moving twice.
Since the loan application procedure doesn’t take the existing house payments into consideration, you have thus the liberty to access any necessary cash you may need for the new project. Therefore, you can refinance the existing residence to the highest loan possible and opt for a low payment or adjustable-rate mortgage. This action enables you to receive extra money for the build and enjoy low monthly expenses during the build.
Home Equity Line of Credit (HELOC) is a second way to get the extra cash out of the existing house. Although allowing you to have access to the respective money, it also increases your current payment to cover the cash you take.
Some construction lenders might advise you to take a bridge loan to finance your project, but this option is considerably more expensive than the refinance or HELOC alternatives. One of the reasons is because the bank ensures both properties, which can result in a sort of finance restructuring blockage if your project goes wrong and you are out of money to pay for it.
II. Punctuality
Next on the list of concerns when initiating the construction loan process is to apply on time. Being given that the related documentation is valid only for 90 days from the time it is signed, you need to schedule your “evolution”. Once the deadline passes, the expiration is applied to your credit report and property appraisal. If you haven’t managed to fund the loan before this, you have to pay for both a new credit report and an appraisal extension or re-certification of value, which is only good for another 90 days.
The best benchmark to use for planning your loan application is represented by the moment when you apply for your permits. Since the latter is one of the most challenging tasks in your preparations for a new house and the majority of lenders don’t grant the loan until the respective permits are in place, you need to take care of this aspect to ensure a good synchronization. The faster the working drawings are approved, the sooner you will be funded.
III. Loan Process Issues When Construction Has Already Begun
If you apply for a construction loan when the building has already started, the main issue to be dealt with is to obtain a title insurance. It is required by the lender as a proof that the loan is clearly secured against the property in case you default your attributions as a debtor. The title insurance comes into force after
- you and the bank close escrow the loan (which implies that all the paperwork is executed and all money is transferred on a prescribed date) and
- the trust deed (a formal document that safeguards the lender’s interests) is recorded with the county.
Another useful piece of related information concerns the problem of broken priority. Such an instance is created if you start construction work on the property before the loan is in place. This means that, if some of your contractors are not paid as agreed, they can file a mechanic’s lien which secures their debt against the property. Since the loan hasn’t yet been given, this implies that they have priority ahead of the creditor.
In order to prevent the possibility of a mechanic lien, the borrower has to arrange with his title insurance company the signing of an indemnification agreement. Thus, he agrees to pay any and all claims by contractors and subs for work completed prior to the date of recording the loan documents. His financials will be examined in order to determine whether he can afford this step and, if everything is in compliance with the requirements, the custom house owner benefits from this indemnification agreement for free.
IV. Paperwork Preparations
If one thing can go as a general rule when it comes to construction lending, that is to keep all the related documents in handy and organized. Thus, precious time and efforts are saved when you apply for a loan. The necessary paperwork that most lenders require before reviewing the loan package have to provide data on the borrower, his contractor and his project. The respective support documentation includes:
a) Personal Documents
- Application (supplied by lender; lists all your personal and financial information);
- Consent form (supplied by lender; allows the lender to verify your information);
- Signed disclosures (supplied by lender; keeps the lender in compliance with the law);
- Most recent year-to-date pay stub;
- Two years’ W-2s;
- Two years’ personal tax returns;
- Two years’ business tax returns (if self-employed);
- Year-to-date profit and loss statement (if self-employed);
- Rental agreements (if you own rental properties);
- Three months’ bank statements on all accounts, both business and personal;
- Most recent statements for retirement accounts;
- Closing statement (HUD-1) for land purchase.
b) Construction-Related Documents:
- Three sets of plans, including working drawings;
- Completed cost breakdown (supplied by contractor);
- Completed description of materials form (supplied by contractor);
- Completed builder statement (supplied by lender);
- Construction contract (signed by contractor);
- Architect information;
- Insurance agent information;
- Contractor’s liability policy;
- Workers’ compensation policy or waiver;
- Course of construction policy;
- Copies of permits or permit applications;
- Copies of paid receipts/canceled checks for items paid and work completed.
V. Locking in an Interest Rate
Although this is one of the most preoccupying issues for custom home builders, it is also one on which they usually have the least amount of control. Not all loan programs available allow the borrower to lock in the rate, which implies establishing the rate at a certain percentage while the loan application process is underway. And if they do, they lock at higher than the market rate you would get on a refinance loan on the same day.
When locking in the rate, the customers practically bet that the market will get worse during their build time. How can they predict such thing? One has to carefully analyze the economics (by reading reliable financial reports) and then ask one’s loan officer to present the lock options on the programs for which the client qualifies in order to make the best “guesstimate”.
VI. Delineating the Duration of Your Construction Loan
The majority of the construction loans are usually granted for 12 months, rarely for shorter or longer periods, with the lower and upper limits of 6 and 18 months, respectively. The exceptions from the standard come with a different rate.
Since it is very difficult to estimate as accurately as possible the length of the building process, it is subsequently hard to determine for how long the loan should extend. If you consider that your custom house will be finished sooner than later, you can save some money upfront if you go for a shorter loan. But you also run the risk of paying penalties for exceeding the time limit when schedule delays interfere with your best-laid plans.
All in all, you might save a little if you complete the build sooner, but you might pay FAR more expensive fines for finishing later that the loan timelines. The principle of safety usually prevails in the loan process, but it in fact depends on each customer.