Tuesday, October 14, 2008

Construction to Permanent Loans in Chicago: Purchase and Renovate

I've invited RWF Mortgage, an affiliate of Wells Fargo, to write about lending programs as a guest blogger. I was interested in buying a house and financing the renovation. Here's one program he pointed out.

Let’s say you’re a buyer in today’s market and you want to purchase a home in your neighborhood but can’t afford the necessary Renovation/Cost needed to bring the home up-to-date. Today’s answer is a Construction to Permanent Loan. A Construction to Permanent Loan is used to acquire a property or a vacant lot, then pay "draws" of the construction loan to a General Contract/Builder to complete constuction or renovation. This is one loan that modifies to an End Permanent Loan after the Final Draw. The permanent loan can be a 30 Year Fixed, 5 Year Arm, etc… The borrower has the ability to lock the rate of the end permanent loan at the opening of the Construction Loan when the project is just starting. The lock can last up to 2 years. The borrower will get a free float down on their interest rate prior to modification, should interest rates go lower.

We recently completed a Single Family Home purchase with a Construction to Permanent Loan. The property purchase and a major addition project to the home were all covered in one loan. The home buyer was required to hire a qualified General Contractor to complete the work. This included extending the back of the home on the first level and adding a large deck. The total cost came to $75,000. The Acquisition Cost of the original home was $450,000. The lender reviewed the sales contract of the existing home, collected the Cost Breakdown ($75,000) and Plans & Specs from the General Contractor to help determine the Finished Value. Along with those 2 things, the Lender took an estimated prorated amount of interest due during the construction period ($15,000) along with the Closing Cost ($5,000), and added these two totals to the Sales Price and Construction cost.

All this added together is the Total Acquisition Cost for the project. The Interest Reserve is an account with the lender that is drawn on each month to make the interest payments on the balance of the construction loan. This interest reserve is an option account, but on this particular transaction, the borrower elected to go with it. The lender lent 80% of this acquisition cost which came out to $436,000. In this case, the appraisal came in a bit higher than the total acquisition cost, so we had no problems proceeding. Should the appraisal have come back lower than the total acquisition cost; we would have lent 80% of the lower amount of the appraisal, which would have required the buyer to put more monies in the transaction. If the appraisal amount were to come back higher than the acquisition cost, the lender will still lend the amount of the original acquisition cost.

During construction, the borrower did not have to make payments while they sold their existing home. The reason, as mentioned above, was an interest reserve account was created to make the monthly interest payments on the construction balance. Also, we did not have to use the buyers existing mortgage payment in qualifying them for the new home. This happens because the construction guidelines understand that the home buyer will sell their existing home or lease the property to a tenant prior to the final draw on the constriction loan.

The 3 main benefits of a Construction to Permanent Loan are the following:

A. Most of the Construction/Renovation Cost can be financed
B. No Payments on the Construction Loan during the construction period
C. Home Buyer’s existing Mortgage on their current home is not used in Qualifying for the new Mortgage (Construction to Permanent). Therefore they don’t need to worry about being able to cover both payments while the home is built/renovated and not does the Lender.

Purchasing a home and completing a renovation or rehab of the property can be easier today than most home buyers think. It’s one solution to improve a property to meet your needs rather than buying an existing home that someone else has customized. A home buyer is able to customize the project to suite their taste. Take advantage of the program in order to have a property that meets all your needs.


Andrew Wilson said...

I am an architect and part-time real estate investor and I recently completed a renovation on a two-unit building in Humboldt Park using this loan product.

Overall, the product was great and I highly recommend working with it. This blog post does a good job of explaining how it works.

If you do choose to proceed with this type of loan, be prepared for the following:
1) Extended underwriting process: several different divisions of Wells Fargo across the country will have to review the loan packet. Each division concentrates on a different aspect of the loan (credit, property analysis, etc.) and it took longer than we expected to get the authorization to close letter.
2) Less than clear construction draw inspection forms. I highly recommend being on site when the inspector comes to review progress for a draw. Deciphering the forms was impossible due to lack of information.
3) Increased complications tracking change orders with your general contractor. Be sure that your contractor is aware of the increased paperwork demands of a loan financed this way, and that he/she is willing to put up with it.
4) No disbursements prior to some construction completion. The bank WILL NOT release any funds to pay required contractor deposits prior to them beginning work. Best to work with a contractor that understands this and is willing to make an exception, otherwise this cash will come from your pocket.

Feel free to contact me with questions about my experience.

Andy Wilson
Email me
[1016] Architecture Inc.

Eric Rojas said...

Thanks Andy... this is the type of first hand experience my readers need to hear. Hope to hear more from you.


Pat said...

I was looking at a single family house in my neighborhood that is currently unlivable because it was not winterized. Is it feasible for the homeowner (myself) to complete the construction? Does it have to be a licensed contractor or just a corporate entity? If so, what is stopping me from going to the courthouse and creating my own company to perform the construction services?

Thanks for the help.

Eric Rojas said...

Hi Pat,

Brian Cumpton is going to answer the question for you. You should call hime or email him about these types of loans.
However, I suppose if you were able to get your GC license, you could possible run the job. However, the lender is the one who okay's the job and may deny you based on your experience. As well, why would anyone want the hassle of General Contracting a rehab?!

Good luck!

Pat said...

Thanks Eric!