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August 15, 2014

Construction Financing

Grass is always greener on someone else's piggybank

If you are considering a project of your own, and need to secure financing, we suggest you start on this as soon as you can, and schedule a lot more time than you think you'll need.

A discussion below.

For new house construction, a typical approach is to secure a Construction Loan.

The idea of a construction loan is this:
The Owner (you?) approaches the bank with a project that needs financing.
The Bank then determines that:
  • what you are building is acceptable (need plans for this), and 
  • that the builder you are using is acceptable (forget about your brother building it), and
  • the budget is acceptable, and 
  • that you as a client are financially an acceptable risk.  
Then the bank issues money to the builder in "draws", based on % complete of the project.  Once the project is complete, the Bank inspects to make sure it agrees, and final payment is made to the builder.  Then the Owner can transition to a longer-term mortgage with better interest rates.

Construction loans differ from mortgages in that the security for the loan does not exist yet.  There is no house (yet) for the bank to take away from you if you default.  So the bank takes extra precautions to make sure their investment is protected.  This means stricter qualifications for the loan, higher interest rates, and a LOT more oversight.

And sometimes, the bank can insist on changing the building itself.

The bank wants to make sure the building is desirable to 'the Market' in case they end up owning the building and need to sell it.  Appealing to the Market as defined by a bank, however, can pull your project down to a pretty low common denominator.  There is nothing unusual allowed. Green building practices have little to no value on their ledgers (this is starting to change ever so slightly).  Exquisite detailing carries equal weight to same-old-same-old.  The things their checklist considers valuable, you may want no part of, and vice-versa.

Don't want a garage?  Sorry, the market wants one.  They also want granite counter tops and huge master suites.  Lots of bedrooms. They don't want to pay for green roofs, or solar panels.  Passivehaus...what's that?

Some people are trying to live with less - less square footage, less bathrooms, and pay for better quality for what they do build.  Oh, sorry, the McMansion market is still dominating.

We like to help people get what they want (and beyond!), but we get most excited helping people who want something different, idealistic, interesting. Sadly, the financial world seems to view interesting as antithetical.

Even if your local bank is progressive and on-board, their underwriter might have their own ideas.  We say this having run into underwriting problems 3 times now in the recent past.  The bankers themselves expressed deep frustration.  The post-bubble financial world is skittish.

Our recommendation is to deal with a local credit union, if you can.  Look for a CU based in your city, who keeps and services their own loans, instead of selling them off immediately to the larger market. They will know the local market, and be able to make their own decisions without running them by employee #46992 on the opposite coast who has their own rules and expectations.

And again our other recommendation is to start as soon as you can to secure financing.  It is a rude shock to have the builder lined up, a permit in hand, and the Bank decide at the last minute not to play along.  Because if there is one thing we've learned the hard way, a preliminary approval is no guarantee of a final approval.  For example: can you believe that a promotion at work can be considered a change of employment? 

And finally, persevere.  It really isn't that hard, just a bit exhausting.

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