From a loan perspective, building a house is not the same as buying an existing house. The time it takes for construction, the many decisions that must be made along the way and recent federal regulations make new home construction a unique endeavor. It also requires a close relationship between the borrower and everyone else involved.
“Borrowers become partners with their loan officer and their builder because of the ongoing nature of the relationship throughout the building process,” says Bob Giacomo, senior vice president, mortgage lending leader at Westfield Bank. “That means there has to be a high level of trust among everyone involved.”
Smart Business spoke with Giacomo about the lending environment for construction loans and the unique characteristics of the relationship between borrower and lender.
How would you characterize today’s lending environment for construction loans?
The lending environment is outstanding. Right now there’s a shortage of available existing houses. Reports indicate the economy is improving and there’s job growth. Since the middle of 2014 we’ve seen the stock of existing available homes decrease, so there’s a demand for new home construction again. The builders who survived the downturn are now thriving.
For perspective, we wrote 57 new construction loans in 2014. The year before we only wrote 18, so that business has jumped through the roof.
What mistakes do borrowers make that leads to their application being denied?
The biggest mistake borrowers make is they don’t get preapproved with a mortgage loan originator who specializes in construction lending. A mortgage professional can help borrowers understand what they can afford. The Ability-to-Repay/Qualified Mortgage rule, which is part of the Dodd-Frank regulations, require that payments not exceed a debt ratio above 43 percent of a borrower’s total income minus expenses. Expenses include credit card debt, any revolving or installment debt, child support, alimony, taxes and homeowners insurance. Borrowers don’t include that number as they consider how much house they can afford.
Those who are seeking to build a new home need to be comfortable making concrete decisions. Changing something midbuild can become a big issue, adding to the costs and possibly requiring the borrowers to ask the bank for more money.
How can borrowers be better prepared to apply for a construction loan?
Upon applying for a construction loan, the lender is going to scrutinize the borrower’s income, credit report and assets, among other things. It’s important to have explanations for any credit challenges the lender sees, or where large deposits came from. It’s an ongoing process, but an originator skilled in this type of lending can make it as painless as possible.
There are many decisions to be made during the six to 12 months it takes to build a house. A good originator can provide valuable help along the way.
Who are some common attributes of the best candidates for a construction loan?
The better candidates for a construction loan are those who are building what will be their second or third home — they’ve purchased a home in the past and built equity they can use for a down payment. It’s typically not a good idea for first-time homebuyers to build because of the time it takes for construction.
Who should borrowers work with to secure construction lending?
It’s often better if borrowers work with a community bank because its staffers often have a better sense of the community and can better streamline the process because of their good relationships with local builders and other necessary parties.
Building a house is a much different process than buying an existing house. It’s important that borrowers see their mortgage loan originator and builder as partners. Once the loan closes, the process is really just beginning because there’s so much to monitor and deal with. Borrowers will be working with these people for as much as a year until the property is done. Good communication is essential to make sure borrowers get what they want from both lender and builder.
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