Private hard money construction loans are a unique type of financing specifically meant to be a bridge loan. These loans are not long term. Rather they fill a need to take a property from ground up or partially built to completion. During this period of time, a property is in a unique state. This unique state requires a specialized financing tool – which is a construction loan.
When a property has nothing built on it, the value of the property is essentially land value. Many construction projects do not have enough equity in the land value to finance the full construction of a build. For land loans typically the maximum leverage point for financing is 50%. Once the construction is completed, however, the value is higher than the land value. Additionally, financing is available at higher leverage points for the completed building than for land.
A construction loan looks to leverage this completed value in order to finance the construction costs. By leveraging the completed value, more dollars are available for the construction. The danger in this to lenders, however, is if the project is not built – or not completed. To mitigate this risk, construction loans use a fund-controlled account for the construction. This ensures that value is increasing as funds are released, maintaining a security position for the lender in the property.
A fund-controlled account typically consists of the cost to complete the build plus contingency. When a construction loan funds, funds are not given to the owner to go build. Rather, money is gradually released from this fund-controlled account as work is completed. Many times these releases are built into a schedule upfront. By doing this, everyone agrees on what work needs to be completed to release the next batch of funds.
These releases are typically done in arrears. So work will be done, an inspection will take place to confirm the work was done and then funds are released for that work that has been completed. If work has not been completed, funds will not be released. In many cases there is an allowance for partial releases. So if 50% of one line item has been completed, 50% of that line item may be released.
For traditional mortgages borrowers need to qualify for the loan based on income. For hard money construction loans income and assets do play a role, but the focus is typically on the cost of the build and the completed value. There may be feasibility studies done to confirm that the budget is sufficient to complete the build. Appraisals are done based on a completed value. Interest reserves may be built into the loan. Past experience on similar builds will be looked at. It is a different underwriting process.
Since these are meant to be bridge loans to bring a property to completion, construction loans are often short term. 12 – 24 months is a typical range for term, although there are always exceptions. There are also construction to permanent loans that will roll into a permanent loan once construction is complete.
Whether building an investment property, a spec house to sell, commercial property, industrial property, subdivisions or other types of projects, construction loans are often a solution. Construction completion loans can also be used in a similar manner. Whether the build was started using cash out of pocket, or with a construction loan that needs additional capital to complete the project, financing is available to help complete the project.
While these projects would all use a construction loan, the structure of the loans would be different as per the needs of the specific project.
We specialize in alternative financing options for properties throughout California – including construction loans and construction completion loans for both residential and commercial properties. Visit us online to learn more about our California hard money loans.