Construction Loan Required?

Question

I am currently looking at several properties that are REO or HUD listings to flip that have varying remodel requirements. A couple of the properties with the most potential are not eligible for a conventional loan because the properties are not "move-in ready". These homes will require a new kitchen, HVAC system, and finishes.

I'm assuming on these properties I will be required to get a construction loan. I have the following questions:

How are construction loans structured? If I buy a house at $50k and estimate the repairs to be around $30k would my loan be for $80k? I'm assuming I would still have to put down 20% or more?

Is there a time restraint on when I have to get all of the repairs completed by?

Do I have to involve the bank in collecting bids and selecting subcontractors for scopes of work? Would it be an issue if I was self-performing a majority of the work myself besides MEP systems?

What are the pros and cons of using a construction loan for a flip?

What other options do I have to finance the project? Could I offer $80k for the home with $30k in repair escrow? Or is this essentially the same thing as a construction loan?

With a conventional loan I was planning on financing the purchase and using cash to finance the improvements. The construction loan seems somewhat advantageous because it requires less cash investment and maximizes the ROI and leverage.

Any input is much appreciated.

Thanks.

J Scott · Answer

A renewal clause is pretty typical in the contract, so you know what your options are to renew if necessary. That said, most of these loans are 12 months, which should be enough time to rehab and resell a residential property -- if it's not, you should rethink your strategy...

Bryan Hancock · Answer

You may also call some of the best title companies in the area and ask who is doing these types of loans. They will generally be happy to tell you to help develop a relationship for writing some title policies on down the line. I had lunch with Independence Title and they were happy to let me know which banks in Austin are doing loans for portfolio product. I can't imagine construction loans would be much different.

Account Closed · Answer

Hello All,I can help you get New Construction loan for building Hotels, Multifamily apartments for single family home flips.This loan would be Private money loan with rate of interest 6 percent with no interest for 2 years.Its an Asset based loan.Thanks

David Robertson · Answer

I spoke to my lender about a purchase and renovation loan and he gave me some surprisingly good news. He said that I could get a 30-year fixed conventional renovation loan at 6.5% for the purchase price+repair value. I like this option much better than the short term/balloon payment option that was discussed here; much less risk of default. Originally, I was going to use cash to finance the improvements which would include the 20% down payment + repairs + holding costs. With a renovation loan I will only need the 20% down payment + holding costs. This option minimizes my cash investment and maximizes my ROI. I will also be able to finance homes that are not "move in ready" which will expand the amount of potential homes to look at. However, it sounds like there are some inconveniences from the bank's oversight/involvement of the renovation: paperwork, bank manages cash disbursement, a contractor may have to be involved (although I may qualify because I have a construction background).

David Robertson · Answer

So refinancing the loan is common if the property doesn't sell? It sounds like it would be important to structure the deal to ensure enough time for repairs and adequate time for listing. I would not want to assume or hope the bank will refinance into a permanent loan structure.

J Scott · Answer

I've used construction loans for about a dozen properties. Typical rates are 6.75%, one-year interest only, 1.25 points upfront, with a 25% downpayment. There is only one bank in my area who currently does these types of loans, and they're actually not doing them anymore (I have a contract with them, so I can get them for a couple more months, then I'm cut off as well). Call the really small commercial banks in your area, and ask to speak with the VP of commercial lending...they're the ones who are most likely to help you. Even if they can't do purchase + rehab loans, there are a number of banks (including mine) that are happy to do purchase only loans for flips -- mine is 80% LTV and same terms as above.

Jon Holdman · Answer

Like hard money loans, a construction loan is intended as a bridge to get to some goal. That could be selling or could be refinancing into a permanent loan. So, yes, a balloon after a fairly short time is common. If you can't pay off the loan or work something out with the bank, they will take the property. And that's how Deutsche Bank ended owning the new Cosmopolitan casino in Las Vegas.

Mike V. · Answer

Yes, balloon is very typical. My bank allows for another 9mo extension or they will refi in-house at 5.5% with a 3 year balloon amortized over 20 years.

David Robertson · Answer

Are construction loans typically structured with balloon payments? Seems risky if the property doesn't sell by the time the balloon payment is due.

Mike V. · Answer

Hey David, I have used construction loans on 5 flips that I have done over the last 18 months. I believe if you can find a bank to do one its a great way to go. Here is my latest example: Purchase price 24K, rehab cost 56K. I had to have ~5K down on the purchase price (20% of 24K) and the bank lent the rest. My bank did not require any formal quotes from contractors - just an excel spreadsheet listing what I planned to do to the property. The appraisal is done based on my completion of the listed items and the bank loans up to 75% of the appraisal. 6.5% interest only payments with a balloon payment at 9mo. I usually pay anywhere from $500-$800 in additional fees to the title company but they handle all payments and 1099s to contractors.