PrePaid Construction Costs and How They Relate to a Home Building Loan
Today I want to review prepaid construction costs and how they relate to a construction loan. One of the common questions we receive is, “Does the money that we put towards our plans, design, permits, and fees before the bank funds our construction loan, actually get counted towards our down payment?”
Construction Loan Application
I want to give you a current example. We have a project that will close on the loan soon. We’re planning to start the project in a few weeks or so. Once the loan closes, we will schedule the grading contractor to start this project. During the initial design stage for a custom home or even an Accessory Dwelling Unit, the customer typically applies for a loan to ensure the amount of money is enough to meet their build budget. This may include the cost of land, site improvements, and the actual construction of the home. Qualifying for the construction loan allows us to make sure that they will be comfortable with the amount of money needed to put down on the project.
Loan to Value (LTV) Calculated for Down Payment
The bank will disclose the LTV or Loan-to-Value allowable for the project. This particular scenario resulted in about 5% down, but 10% and 20% is pretty typical, even 25%. Keep in mind that at least 20% down is required to avoid Private Mortgage Insurance. If you already own the property prior to closing on the construction loan, meaning that you’ve taken title to the property, the bank will establish a loan-to-value, as opposed to including the land purchase with the construction cost, which is a Loan-to-Cost. I reviewed a Loan-to-Cost a few weeks back. This particular property appraised at $770,000. The actual loan amount came in around $730,000. This customer needed to put 5% down into this project. That was the minimum down payment required on this project.
Before the Construction Loan Approval
Prior to the loan approval, we worked with this client in which they had paid for the plans and design process. We submitted the final plans to the county which started the permitting process. During this process,we paid plan check fees, permit fees, water meter fees, etc. That is a large chunk of money. Altogether, these fees added up to about $46,000. That equates to a little more than the required 5% down payment. The customer paid for these funds outside of the building contract.
Include Costs in Your Construction Loan Application to Allow Disbursement for a Down Payment
The contract for this home was written to include all those expenses. The total expenses came in around $720,000- $730,000 to build this house. Once we had the costs and builder agreement, we gave the lender a billing schedule. A billing schedule essentially identifies the draws that we get at certain stages of the project. The initial disbursement of funds releases once the loan closes. This particular bank, One Trust Bank, will give a 5% disbursement to the builder. The customer will benefit from including these costs in the loan so long as they can provide receipts to the bank showing proof of payment. Once the proof has been verified, the bank will count those monies against the down payment. This prevents the customer from having to bring more money to the closing in order to complete the project.
Down Payment for a Construction Loan
The customer can use the original $46,000 as their down payment. On the Builder side, the bank reduces that $87,000 line item on the first draw by $46,000. This results in about $40,000 that can be drawn off of that line item, but it still limits that to 5% on the initial close. The bank disburses that money via wire into the builder’s account at the initial close of escrow. This protects the client from having to come up with additional monies for the down payment requirement after spending out of pocket expenses during the plans and design process.
Construction Loan Closing
Another common question is, “Do I have to have a permit before the construction loan closes?” The answer is no. There’s a certain timeframe for construction loans. This particular bank timeframe is nine months. They give us nine months to complete a house before they charge an extension fee. The best case scenario is to ensure that the permit will be issued very soon to closing. A two, or three-month permit lag time delays the project from completing within the construction loan period before needing an extension.
Some banks make extensions easier and affordable, other banks do not. Some extensions cost thousands of dollars. Making sure that the plans have been submitted to the County or City for processing will give a good timeline on when the permit will be issued.
Additional How to Buy Land and Home Building Resources for San Diego County
I hope that helps. If you have more questions, or if you want more information about building a custom home, or buying land, review our website. You can go to our resources page. We have a lot of information to download on buying land. We have a How to Buy Land Guide, a Custom Home Building Cost Guide, and an ADU Cost Guide. We also have a comprehensive FAQ page that you can take a look at. Take a look at our comprehensive collection of similar videos on our YouTube channel, The Real Property Show. Thanks for your time today, and have a great rest of your week.
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
6 Comments
Great tips provided. Thanks a lot.
https://zippyfinancial.com.au/
You’re welcome! Glad it was helpful.
I appreciate the thorough research and analysis presented in this article. It provides valuable insights into the current state of the industry and the trends that are shaping it. Thank you for taking the time to share your knowledge with us.
Thank you for kind words and taking the time to view our blog post!
Thank you for sharing the informative article.
We’re glad you found the information in the article helpful. Thank you!