General Construction Lending Considerations
Basic items to determine when considering a construction project:
What is the construction term required? ( 6, 9, 12, 15, 18 months)
What is the cost to build? (contract between borrower & builder)
What is the lot value or cost? How long owned? Balance owned?
What is the future appraised value ?
Three considerations regarding construction budgets:
Ø Loan to value (LTV) guidelines
Ø Loan to Costs (LTC) guidelines
Ø Elements of the Budget
Preliminary Loan Budget Summation Points (Five costs of a Budget Worksheet):
Soft; permit fees, architect fees, school taxes;- the intangible costs associated
with the project.
Hard; sticks, bricks, and nails - the cost of materials and labor used to build.
Land or 1st lien; Includes equity and any lien/mortgage information.
Closing costs; origination fees, discount fees, appraisal, titlle, escrow etc.
Reserves; Consists of two numbers: contingency reserves, which ccovers any cost overruns that
may occur, and interest reserves, which makes the interest payment during
construction, so that borrower doesn't have to.
For LTVs most construction lenders will provide a percentage, usually from 60 percent to 80 percent of the completed value of the property in the form of a construction loan. Once the value is determined, a lender will judge that the project can be completed by a reasonable contractor at a percentage substantially below the final value.
Along with LTV, some lenders will constrain their construction loan to any where from 80 percent to 90 percent LTC for smaller projects. For larger projects bankers are approving LTCs that are even lower. Even if the project can be completed within reasonable LTV guidelines, the lender may still want the client to have significant “skin in the game” by bringing a portion of the hard cost to the closing table even on the most promising of loan scenarios.
For budget ratios, when you review the construction budget, the numbers need to be in line as a percentage of the total construction budget.
A residential builder’s numbers should fit approximately as follows:
Raw land cost: 14.5 percent
Lot improvements: 11.5 percent
Materials: 24.3 percent
Labor: 20.3 percent
Builder overhead: 7.6 percent
Financing charges: 4.3 percent
Marketing and sales: 6.1 percent
Advertising: 3.1 percent
Builder profit: 8.3 percent
Total construction budget: 100 percent
The above percentages are from the Professional Builder Magazine.
A more simplified approach would be to follow the 25/50/25 rule which allocate the percentages of costs as follows:
Ø About 25 percent of the total project for land and land improvements;
Ø About 50 percent for hard costs including labor and materials; and
Ø About 25 percent for all soft costs including overhead, debt service, sales/marketing
and builder profit.
The above numbers are not carved into stone, however if the construction project dose not fit within the boundaries of reasonable LTVs, LTCs and internal budget considerations financing the project may be difficult.
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