By David Baron
How Construction Loans are Made
Construction loans are subsided in increments to supplement the progress made on the development’s construction. Since construction loans are short-term loans, they must be paid in full in accordance to the loan period that is soon after the construction is completed. Construction loans can consist of a period of time ranging from 12 months to 24 months. Within this timeframe is a window period that takes unexpected problems including bad weather, delay of materials and supplies, as well as labor problems into account. During this timeframe, the borrower is responsible for paying any interest that accumulates on the outstanding balance that is owed. The longer it takes to repay a loan, the higher your interest charges.
How Construction Loans Are Used
Although construction loans are short-term loans, which are a great return on investment, its high risks create strict guidelines and regulations for borrowers. Lenders need to guarantee that the value of a borrowers’ collateral is sufficient enough to cover their outstanding balance.
In addition, lenders require the borrower to provide a takeout commitment from another lender. A takeout commitment will ensure that all the requirements have been meet upon completion of the development’s construction to safeguard repayment of the construction loan.
Lending Parameters and Guidelines
Although construction loan lenders follow a general set of guidelines, lenders tend to amend these guidelines to suit their own regulations.
1. Loan-to-Cost relationship is representative of the most amount of money a lender will lend in accordance to the amount of the takeout commitment used for repayment. Lenders are hesitant to lend more than 75-80% of the finished development appraised value. However, many construction loan lenders tend to follow the former industry standard and will loan an upmost of 100 percent of costs. Recently, lenders have been more concerned about 100 percent lending and will therefore entail that the borrower fund cash equity either into the closing or the initial phases of the loan.
2. Bonding requirements are an integral part of construction loans. Performance bonds confirm that the construction contract will specify that the plans and provisions are used to complete construction on the development. If the general contractor is no longer with the project, the surety of the bond is allowed to hire another general contractor to complete construction.
For more advice on construction loans contact our Palm Springs banking practice law firm today.