How to Use a HELOC to Fund a Construction Loan if an Appraisal Comes in Low
Sometimes the appraisal comes in too low for a construction loan. So I’m going to give a recent example of how we resolved this issue using a HELOC.
Construction Loan Lender Package
The typical process for getting a construction loan includes completing a set of drawn plans, signing the building agreement, and completing the specification package, and completing the cost breakdown. That’s what we call the “Lender Package”.
After the Lender receives the lender package, the lender hires a third-party appraiser that completes an appraisal on the property. Now, the way that works is, the appraiser looks at that lender package and considers the size of the home, size of a lot, property location, and level of finishes planned for the home. Then they find previously built comparable properties that have sold homes to compare the value. Those comparable properties enable a post-construction valuation of what this home would be worth, and that will be their appraisal.
Construction Underwriting: Debt-to-Income
Depending on the lender, they have different underwriting guidelines, as far as how they determine the max loan-to-value that they offer. Lenders look at your debt-to-income ratio based on what the total loan amount is, and see if you can cover this with your income. The loan to value can vary a lot. It could be a 30% debt-to-income ratio and all the way up to 50% debt-to-income ratio. Once you submit your financials to the lender, they will qualify you for a certain loan amount.
Construction Underwriting: Loan-to-Value
The other thing lenders look at is the loan-to-value ratio. They consider the value of the property, which is established by the appraiser, and then provide you with a percentage to lend on the property. If they offer an 80% loan-to-value, then they’ll lend up to 80% of that property’s value, which was determined by the appraiser. This means that you must have a 20% equity position in the property, or a 20% down payment. If they offer a 75% loan-to-value, then they lend 75% of the property value, which requires either a 25% active position or 25% down payment.
Construction Equity Position
Obtaining that down payment or equity position can occur a couple different ways. This particular client already owns the property free and clear. Remember that all property has a value by itself, even without an existing house. Since there’s no land loan or anything on there, the owner holds a 100% equity position on the land.
There is another way to get a down payment by taking the money out of the bank and putting it into the deal. On this particular deal, here’s what happened. The requirements for this project increased the build costs higher than normal. Currently the build costs are right around $800,000. The appraisal came in at $875,000. These owners now have an $875,000 property value and they maintain a $75,000 equity position.
Finding $100,000 to Reach 20% Equity
The lender wants them to have a 20% equity position, or 20% down payment on this property, and will only lend up to 80% of the loan-to value, or value of the property. Now the owners are short about $100,000. If you multiply the $875,000 by 20%, it results in $700,000. Since the total cost to build this project is about $800k, we have to get from $800k down to $700k.
Where do we get the hundred grand? The solution to this problem, which the bank allows, is a home equity line of credit on their existing home. This allows them to use that as the additional $100,000 down payment for this project.
Debt-To Income Ratio
The debt-to-income (DTI) ratio is important to consider in this scenario. If the lender allows a 45% DTI (debt-to-income), and you’re at 44%, the lender will recalculate the DTI to include the $100,000 equity line out on your primary residence. Whatever the terms are in that HELOC, they will look at the maximum payment possible on the terms of that loan, which is your debt service. You must make sure that your income is high enough so that DTI doesn’t exceed the underwriting guidelines for the construction loan. Once the DTI has been verified with the HELOC, the lender will accept the $100,000 to help disperse the funds for the construction loan to complete the project.
Navigating Around a Low Appraisal
That’s one way to get around a low appraisal. There are other ways to work around a low appraisal, but this works really well, especially when combined with a primary residence. HELOCs are easiest to obtain on a primary residence. You can also get them on investment properties, but the loan-to-values are much lower. Investment property HELOCs do not afford as much money, and only a few banks offer that kind of program. Some credit unions offer an investment property HELOC more often because of where the investment funds come from.
Using a HELOC to Fund a Construction Loan with a Low Appraisal
I hope this helps. If you’d like more information on how to build a home, buy land, or anything else, take a look around our website. Our resources page has a ton of information. There’s also an FAQ page that has a lot of information as well. Thank you so much for your time and have a great rest of your day.
We Build CUSTOM HOMES, ADUS, & Do HOME REMODELING
Top Notch Quality Homes, on time, on budget, and without hassles.
Freeman’s Construction, Inc. has been building new custom homes and completing whole house remodeling projects in San Diego County for over 37 years. To schedule a project consultation, please call us today at 760-788-6846 or fill out a request form.
Areas We Serve:
Ramona, CA | Poway, CA | Escondido, CA | Julian, CA | San Marcos, CA, | San Diego, CA | Rancho Santa Fe, CA | Lakeside, CA | Rancho Bernardo, CA | Scripps Ranch | Carmel Mountain Ranch | 4 S Ranch
