Construction Loan Structure??

Question

Hey there BP!I need some advice on how construction loans "typically" work.I am working with a private lender on a construction note., now this is not a typically loan that this individual provides, but he is willing to do so. My question is... what is a "common" structure for payments and draws? Is is common for the lender to need to see invoices and receipts every step of the way? Also- he is now mentioning having our attorney pull a title update with each draw? This seems rather cumbersome and expensive, is this "common"? He added a section “Conditions to Advances” – the work relevant to the draw is completed, you will present invoices or receipts, you will have lien waivers from any contractors who have worked up to the time of draw request.draw request must align with what is outlined in the SOW.....I feel like I'm being micro-managed, instead of in control of my rehab!Is this usual? Am I over analyzing this or looking at it in the wrong perspective? Please share your thoughts and advice!! thanks!Allison :)

Jon Holdman · Answer

Is this new construction or a rehab?There really is no "typical" in this sort of situation. When I've been involved in deals like this, the details of exactly what constituted done enough to get each draw were fuzzy. But there were typically only two draws. One when the work was "half done" and the other when it was done. No receipts involved. Simply inspection of the work. The final one is easy. Is everything done? The middle one is more complex, since spending half the money often doesn't look like "half done". You often have to spend well over half the money for the project to look half done.Lien waivers are a good idea. As the lender, I'd want to see permits and inspector signoffs. I was burned on this by one borrower. If there are multiple draws, having specific goals for each draw seems reasonable to me.Micromanaged would be telling you what kind of tile to use and what color paint to use.Pulling title updates should not be expensive. Title companies here do simple title reports (owners & encumberances or O&E reports, as they're called) for free. These aren't full title searches, but presumably one of those was done when you purchased. The lender is simply verifying no liens have been placed on the property. On the more recent loans my broker does (I don't do these direct any more), one of the default conditions is that no other liens can be placed on the property. So doing this search makes sense. If a lien is found, not only would you not get the draw the loan would now be in default. I've been the lender on a defaulting loan and it is NOT any fun.

Jon Holdman · Answer

What are the amounts we're talking about?I'll run through this with an example that would work for the lender I work with.Say you're buying for $80K and have a $20K rehab budget. Lets also say ARV is $140K and the lender will give you 70% of ARV. So, the loan amount would be $98K. There would be four points out of that up front, plus some other closing costs. I'm going to round numbers here, so I'll say there are $4000 in points and $2000 in other up front costs. The lender would divide that rehab budget into thirds, say $7K, $7K and $6K. They would typically give you the first third up front and hold the remaining $13K in escrow.So, at closing you would have the $98K coming from the lender. You have debits of:$80K to seller$4K points$2K other closing costs$13K rehab into escrowFor a total of $99K of debits. You would need to bring $1K to closing. But you would have "received" the first $7K of your rehab money. Its going to cover the up front costs. So, you're going to also have to have some cash of your own to buy materials and start paying for labor.Now you start doing the work. When its "half done", you request an inspection by the lender and, assuming you pass, they hand over the second third, $7K. You finish the work, get it inspected, and get the last third, $6K.Meanwhile, you're going to paying a monthly payment of $1225. That's the interest only payment on your $98K loan. Yes, you're paying interest on money you've not yet received.You mention you're DIY'ing this and using a handyman. There are a lot of tasks in a rehab that typically require permits. Electrical, plumbing, HVAC, roofs, windows, siding, etc. If you were doing any of that sort of thing and were borrowing from me I'd require you to get permits. In many areas, you cannot pull your own permits unless you're occupying the house. So you need a GC to pull permits for a big remodeling project, or individual trades to pull permits for specific items. Say you're just doing paint and carpets (which usually don't require permits) but also need to replace the furnace and water heater (which do). You could have the folks doing the furnace and water heater pull permits specifically for those items. But if you're remodeling the kitchen and bath and doing plumbing and electric, you'll need a GC (general contractor) to pull a "remodeling" permit. That often requires changes you might not do on your own, such as putting multiple GFCI circuits into a kitchen or arc fault circuits into bedrooms. I would require you to get those permits and I would want to see them signed off before the draws. I would verify the final inspections were completed with the city before you get the last draw. Can you tell I've been burned on this point?

Jon Holdman · Answer

I've been on both sides at different times.As the borrower you would like as much of the rehab money up front as possible. As the lender, you would like to give out as little up front as possible. When the loan is first made, the price you're paying is what its worth. So handing over more than that amount means you're risking some of the money. In the example above, the purchase price is $80K yet the lender is handing over $85K at closing. ($98K total loan amount less the $13K in rehab budget that's held back.)

Allison Ezzi · Answer

HI @Jon Holdman !This is such great information, I really appreciate the example, thank you! The loan we will be doing in 75k. As of now (until contracts are signed) we have it with 3 draws, beginning, "middle" and end, with inspection before second and third draw. Because we are working with private money ( kinda of like a family friend) we have a little "flexibility" to work out structure. We were thinking 1/2 up front,(remaining in escrow) then draw remaining quarter, quarter? See any concerns there?As far as permits, we are doing a mix of trades to pull and GC for kitchen area. Our lender as asked for permit application info. It is probably wise, to do permit sign-offs before draws, thanks on that heads-up for both sides.I can feel that you have been through this! Not sure which end, but regardless, your experience will help someone else in the long run:)Again, thank you very much for the help! We shall see how it unfolds.-Allison

Allison Ezzi · Answer

Thanks @Jon Holdman I appreciate your feedback greatly:)This is a loan for a rehab vs. new construction....I guess we are just referring to it as "construction loan." We worked with the same lender for the purchase of the house and he is in first lien position. I can see where what is "constituted done enough" can create fuzziness for draws. You mentioned using only two draws? We are working with a Handyman and doing physical work alongside too, I'm just having a little difficulty imagining the draws as our interest will accrual with each draw (did I mention this is our 1st flip!!... sorry rookie questions here:)) Maybe an initial draw for 10k to use for the misc. tasks/materials that we do, and then 2nd draw when half way through top pay contractor, then one at completion? Again, I guess I'm trying to grasp the over process here.Thanks for your guidance!