Construction Lending PrerequisitesBanker Resource
December 20, 2012 — 1,125 views
Navigate the Nuances for Construction Lending
Understand that the requirements for construction lending involve criteria and mandates established to protect both the lending institution, mortgage brokers and, ultimately, the consumer.
Know that the loan is of a short-term nature, converting to a permanent credit product once building concludes. Recognize that these loans are superb for the customer who owns property currently, as the land often serves as sound collateral for the credit issuance.
Consider the following criteria when evaluating a consumer's application for construction credit.
Evaluate the Consumer's Capacity to Honor the Loan Agreement
Know that the customer's financial ability to repay the loan product is the most important aspect of the credit application. Understand that as the construction phases, capital is distributed in what are termed "draws", determined by each phase of building finished at designated intervals.
Remember that the lending institution charges interest amounts based on the capital dispersed, and that the consumer must create a fund of capital known as an interest reserve to meet the interest payments. Gather that the interest payments are drawn monthly from this fund until the construction is finished.
Know that the borrower must provide evidence of income and other existing liabilities, and that these two amounts must be calculated to determine the debt-to-income ratio. Observe an industry standard for this ratio to not surpass 36 percent, even though some institutions due permit a roof of nearly 45 percent, considering the amount of capital to be lent.
Determine the Credit Score and Cash Reserve Limits
Factor the borrower's credit score and the accompanying cash reserves. Factor that the credit score benchmarks shift depending on the amount of credit desired. Observe the standard scale where the higher loan amount requires a higher credit score. In addition, consider that the industry typically requires capital reserves totaling six months of PITI.
Confirm Construction Budgets
Scrutinize the costs of construction, as the amount of the loan requested serves to meet these liabilities. Ensure all costs are included in determining the amount of the loan, including construction costs, permitting and planning fees and any other liabilities and costs related to the credit product.
Value the Worth of the Home
Determine the loan-to-value of the prospective property to ensure that you, the lender, are protected in case of default by the borrower. Factor in that this ratio is calculated as the percentage of the appraised worth of the property less the mortgage amount due.