Recently a friend of mine called me and said that he needed a construction loan to remodel his house in Burlingame, CA. I asked him if he had a construction contract and plans. He said not only did he have those items, he had already started construction!
I asked him why he was calling me now, didn't he already have a construction loan in place? He said no - he was approved for an equity line of credit, but when the lender found out that construction had already started, they could not fund the loan.
I told him I would do my best to find him a construction loan, but I could not guarantee anything. Lenders usually do not like to approve a construction loan application after the project has started.
After making several phone calls, I found a bank that was interested in funding this construction loan. Luckily, my client was financially qualified, and very organized with his paperwork. We got the loan approved, and it recently closed escrow!
There are several lessons homeowners should know that my client learned from going through this process to obtain a construction loan.
Before starting construction, a homeowner should make sure he has the financing of the project approved. It could be a construction loan, a line of credit, a margin loan, etc. No matter what type of financing it is - have it nailed down. Having financing in place not only makes sure the homeowner can finance the project, but also will save the homeowner from a lot of paperwork headaches and stress!
Another tip when obtaining a construction loan is to alert your contractor that he will need to supply documentation to the lender. This documentation usually is made up of a resume, list of completed projects, insurance, and financial statements.
Regarding financial statements of the contractor, it is a good idea to find out the amount of working capital your contractor has. In many cases suppliers will ask to be paid prior to the bank supplying funds from the construction loan. If the contractor does not have enough working capital to fund the suppliers, they may place a mechanics lien on the project. A homeowner may want to consider writing into their construction contract the ability to pay a supplier or sub-contractor directly if the contractor is unable to. This ability can help avoid an issue with a mechanics lien.
If for some reason construction has commenced prior to obtaining a construction loan, make sure that you keep copies of all receipts and cancelled checks. The construction loan lender will want to see these.
Finally, make sure you understand all the terms of the construction loan. The key points to know are:
- the interest rate and how it can change
- the term of the loan
- how often funds are disbursed
- who the check for funds is made payable to (homeowner, contractor, or both)
- whether or not the bank will provide a permanent loan to take out the construction loan upon completion
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