Residential construction loan question

Board Topic: Construction Loan
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Construction Loan

Posted by: mly Sep 2 2004, 09:01 AM
I am about to buy a new house. The house is not even built yet. The builder will let me choose between conventional and construction loan. For the case of conventional loan, the sale price will be $27,000 higher than if I were to do construction loan. What choice should I make? what are the main advantages and disadvantages of convention and construction loans? When do I know that construction loan is right for me? Please help.

Posted by: loanuniverse Sep 2 2004, 02:17 PM

Normally, the way a developer will work is that prior to starting the construction the houses or condos are sold on a “pre-construction” basis. During these period, prospective buyers get a chance to “reserve” the unit by giving a deposit from 5% to 20%. This does not mean that they have to get a loan at that moment, it just means that those units enter into a contract for a later day closing at which time the loan will begin.

Of course buying something that has not been built carries a certain level of risk {specifically performance risk from the developer}. As a result, most units sold during pre-construction are sold at a lower price than once the units are ready to be occupied.

I was confused when I read your post because I could not figure out what kind of construction loan the developer wanted you to get, but after reading that ” the sale price will be $27,000 higher than if I were to do construction..” I guessed that you were actually being offered the chance to buy the house prior to it being constructed.

If indeed you are talking about two loans, please provide more information about terms so that they can be compared. The most important aspect here in my opinion would be taking a risk on the ability of the builder to complete the house if you have to take a loan prior to construction rather to waiting for the house to be completed.

Proper due diligence on this builder would be a most in either scenario. This includes asking for addresses of houses built by this builder, researching state license records, researching the corporate records, and other places like the BBB.

Good luck.

Posted by: mly Sep 3 2004, 01:33 PM
The price of the house (pre-construction) is $600,000 if I obtain the construction loan to fund the construction. If I were to choose conventional loan, then the builder has to get the loan himself in order to fund the construction. He estimates that the interest and closing cost on this short term loan would add up to be $27,000. Therefore, he rolls that additional cost into the cost of the house when selling it back to me after the construction is completed. The length of time of construction is 9 months. If I get the construction loan, then I still have to pay the interest on the short term loan myself, but I do not think that it would equate to $27,000. During the construction, the builder will make 6 draws, therefore the short term loan principle will increase in 6 steps.

Posted by: loanuniverse Sep 3 2004, 02:16 PM
You are more than likely right about actual costs to you or the builder not getting close to $27,000. If the house is going to be sold for $600,000, there is a good chance that the loan will be for much less taking into account that construction loans work with a loan-to-value and loan-to-cost between 75% and 85%. We are probably looking at a loan with an average outstanding of less than $300,000 and a fee of probably $2,000 to $4,500.

The problem here is not so much if you can save on costs, but are the savings big enough to compensate for the shift in liability from the builder to you? Because the lender will be coming after you in case the house is not completed.

Is this house to be built part of a development? Who owns the lot? Do you have to give a deposit if you decide to go conventional and not be involved with construction financing?

I think the builder is playing it very well. If his company can get the credit, he can make an additional $10,000 to $20,000 just for carrying the financing.

I keep saying this, but it never ceases to amaze me ”I am in the wrong business”
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