Construction/Renovation Loans

September 28th, 2009

Construction/renovation loans are a bit complicated, you really have to be dedicated to the process, and be ready to take this on as a second full time job.

A construction/renovation loan is typically used when you are building a home from scratch, or have a large renovation.

The initial “acquisition loan” to buy the house and then start the renovations is usually an “Interest Only” loan based on “Prime Rate”. So you may pay Prime Rate + 1%, for example, during the construction phase. Banks usually restrict your time period on the construction, for example they may give you 6 months to complete the work. After the construction is over, you get a “permanent loan”, with a market rate for a traditional loan (like a 30 Year Fixed Rate), that is locked-in at the time the work is complete.

There is some interest rate risk, since you won’t get your “permanent loan” with a final fixed rate, until the work is complete. This could be quite a risk. Obviously a benefit with a finished home not needing construction or renovations is that you can “lock-in” an interest rate right away.

Also, a construction/renovation loan is a complicated, time consuming and paperwork intensive event. The bank will want to pre-approve your plans and specs, your General Contractor, they will want to see a draw schedule, and more. So you would have to get a contractor, architect and draftsmen, all in advance of loan approval. It takes quite a while just to get plans & specs alone. I have renovated a few homes, and it took me 4-6 weeks just to get plans & specs. These delays are a hassle many sellers won’t wait for if you are trying to buy a house with a Construction/Renovation loan.

Banks will not let you act as your own General Contractor, so you must secure a good GC. And finding a trustworthy GC who has referrals and is professional can be difficult. The whole construction/renovation process can be painful and emotional. There are potential cost over runs, delays, problems with the GC or the sub-contractors, permitting issues, and more surprises.

Some people suggest finding a home that is done the way you want, or at least close
to the way you want, and then any renovations comes down to a much smaller amount of money that you could fund on your own, or pay as you go piecemeal, by doing smaller projects on your own. Maybe you’ll find yourself painting a few rooms, remodeling a bathroom, and putting in some new appliances. If you insist on pursuing the renovation of an existing home, or the construction of a new home, read on for more information.

As I said, finding good contractors can be very difficult. Here are some red flags to look for:

* They do not have a contractor’s license to show you or a license number on the business card.
* You had to call more than once to set up the appointment.
* They do not show up, and then calls you late to reschedule.
* They say they are very busy but you will be “worked in”.
* They say they only do big jobs, but will do this one “just for you”.
* Seems unfamiliar with what you are talking about or dismisses your point of view.
* Starts puffing up the job needs right away.
* Seems slick – you are uncomfortable or you have a bad feeling.
* Offers no physical address.
* Does not offer referrals of satisfied customers.
* Says you don’t need a contract – likes to work informally.
* Can’t quote actual costs and says he will work hourly until the job is done.
* Says you don’t need permits – this is usually nonsense.
* The contractor is evasive about insurance coverage.
* The contractor is vague about referrals or offers only two or three.
* The contractor doesn’t belong to any professional or business organizations.

Take your time and be thorough in your search. Here are just a few places to start looking for the best contractor for your job:

The internet is a great source. A well known web site for contractors is The National Association of Home Builders (www.nahb.org). Also check with:

* Relatives
* Friends
* Neighbors
* Business Colleagues
* Lenders
* Architects/Designers
* Real Estate Agents
* Suppliers

Finding reliable Contractors has never been particularly easy. It doesn’t seem to matter who refers you to someone good, you can follow all the conventional rules to screen people and still come up with someone who does a shoddy job, takes your money, and won’t return your phone calls.

“Real world” information on the subject is hard to find. Most conventional wisdom on finding and dealing with contractors is authored by people who write for a living and don’t have the advantage of hands-on experience in construction. The below comes from an actual contractor:

FIRST, it simply is not easy to find a good contractor.

* Yellow Pages are real hit and miss, and flyers in your mailbox, or posters on a telephone pole, are usually invitations to disaster.
* Referrals from friends and neighbors are a good start, but those referrals need to be qualified and checked as carefully as you would anyone else.
* Material suppliers and hardware stores are a possible resource, but those referrals need to be qualified and checked as carefully as you would anyone else.
* Engineers and architects can be good sources, but those referrals need to be qualified and checked as carefully as you would anyone else.
* Property management people work with contractors on a routine basis, but those referrals need to be qualified and checked as carefully as you would anyone else.

The absolute best way to find a good contractor is by trusting your instincts, using common sense, and educating yourself about what needs to be done. You don’t have to be an expert in plumbing, or carpentry, or heating and air conditioning, or whatever else by any means. But some time spent on research will put you in a position to evaluate what you’re being told by the contractors you’re interviewing for your job. We spend two weeks researching consumer magazines before buying a $50.00 toaster, then turn around and spend thousands of dollars on a renovation project without exercising due diligence in checking out the contractor thoroughly.

SECOND, be prepared with specifications and a budget if your job is fairly extensive. Contractor’s can give you the price of what you want done, or they can tell you what they can do for what you have to spend. But ideally, you’re going to specify both exactly what you want done along with a close approximation of how much you can afford to spend. Professional contractors and tradespeople will appreciate you taking care of these basics, will be more responsive as a result, will quickly determine if you can afford what you want, will help determine how much of what you want is possible with your budget and you’ll have the assurance that everyone you’re interviewing to do the work is pricing the same job.

THIRD, find a contractor with an established business.

* Please don’t misunderstand, everyone has to get started at some point and the fact they don’t have a lot of experience doesn’t mean they can’t do a beautiful job. Get an idea of what experience and training someone new to the business has and help them launch a new career if you feel comfortable.
* Check at least a half dozen references by phone, and go to the trouble of looking at some jobs the contractor’s done in the past if you have a project more extensive than a minor repair. It’s always a good idea to actually talk with the people who had the work done.
* Ask the contractor about who he or she uses for materials and supplies.
* Call the contractor’s bank to determine if their account has been handled responsibly.
* What professional association(s) does the contractor belong to? NARI members are good bets. (The National Association of the Remodeling Industry)
* Make absolutely certain the contractor is insured for both Worker’s Compensation and General Liability. Don’t take the contractor’s word or accept a copy of an insurance binder from the contractor. The only proper way is to get the name of the contractor’s insurance carrier, look the number up in the phone book yourself, then call and ask for a Certificate of Insurance. The carrier will be happy to send you one.

FOURTH, remember that the key to a good job is a good contract with detailed specifications. This means get things in writing every single time you have work done stating exactly what you expect, precisely what you understand you’re agreeing to pay, and when you’re going to pay it. No doing business on a hand shake! IF A CONTRACTOR BALKS AT DOING AN EXHAUSTIVE JOB OF DETERMINING WHAT YOU WANT AND PUTTING IT IN WRITING, FIND ANOTHER CONTRACTOR. Having a good contract is basic to being a professional.

FIFTH, your job has got to be administered closely.

* Somebody’s got to look at what’s going on frequently and carefully. No one is going to be more interested in your job than you. Take time to talk with those actually doing the work. Don’t get in the way, but let workers know you’re interested in the work being done.
* Periodic progress photos are an easy way to resolve questions and disputes, and track progress.

SIXTH, you control the job, by controlling money.

* Don’t give down payments for materials, mobilization costs, labor, or anything else unless you REALLY KNOW WHAT YOU’RE DOING. Whoever has the money, wins. Make sure you’re the winner.
* Don’t pay for work not done to your satisfaction because whoever has the money, wins.
* Set up progress payments based on when certain phases of the work are completed. There’s no question about when the painting starts, there may be an argument about when the painting is finished. The rule is, whoever has the money, wins.

I think I have made my points, and I hope the above helps!

Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.

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2 Responses to “Construction/Renovation Loans”

  1. M Ross says:

    Excellent article. I am about to buy a foreclosure that is essentially the same state as the home in your picture above. I was told that more than 50% of the work is done….with the finishing work to go. Will a bank finance one these “construction to completion” loans with 20% down on a shell?

  2. brianm says:

    I do not believe a bank will approve a foreclosure if you need to use 203k financing. Since a 203k loan is so lengthy to process, and you need to get a contractor, plans & specs, etc; it would take too long. I think they want to know you can pay cash for a property that needs a lot of work. But you can always write up an offer based on 203k financing, and see if they accept it.

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