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Construction Loan FAQ

How long is the construction term?

   A Construction loan typically has a 12 month term which begins on the date the borrower signs the loan documents.  Terms from 12-24 months may be available.  

Can the borrower/owner also be the builder?

   Yes, in most cases the Lender will allow an owner/builder. 

How much can the borrower get for start-up costs?

   The borrower can request start-up funds to help get the construction project going. Typically, a lender will disburse 5% of the current construction amount. They will also disburse funds for upfront expenses such as permits and utility connections upon verification.

Can the borrower get reimbursed for pre-paid items?

   The borrower may be reimbursed for items that have been pre-paid that are not in the budget as equity items.

What are hard costs?

   Hard costs are direct costs associated with the labor and materials used for the actual construction of the home. Hard costs are also known as "direct costs", "board and nails”, "on-site costs" and "hard cost improvements." Hard costs are disbursed based on an inspected percentage of the overall completion of the project rather than the items allocated in the budget.

What are soft costs?

   Soft costs are indirect or "off-site" costs not directly related to labor or materials for construction.  Examples of soft costs include building permits and architectural fees.  Soft costs are disbursed monthly on an "as needed" basis, with invoices, receipts, cancelled checks or other evidence of payment.  However, soft costs such as builder overhead/supervision are disbursed in proportion to the percentage of completion of the home.  

How does the disbursement process work?

   Disbursements on a construction loan are designed to reimburse the borrower as the construction of the home progresses.  Lenders will disburse construction proceeds based on the amount of work that has been completed on the project.  For example, if the construction budget is $100,000 and the project is 10% complete (based on the inspector's view), the lender will disburse the borrower up to $10,000 on the project.  This disbursement would be in addition to any advances or deposits the borrower may be entitled to receive.  Disbursements for soft or direct cost expenses must be verified by an inspection.  

Who does the inspections?

   A third party, contracted on the lenders behalf, performs the inspections. 

What is the Lender's Contingency Account?

   A Contingency Account is money set aside for unforeseen circumstances or cost overruns that may occur during the construction or improvement of a home.  Disbursement of these funds is on an "as needed" basis and will generally be in proportion to the completion of the home.  Of course, as with other costs, a Draw Request is required for disbursement of these funds. In addition, evidence of the overrun will also be required in the form of receipts, paid invoices or cancelled checks.  Once construction is complete, any money remaining in the Contingency Account can be disbursed to the borrower upon his or her request.  

What is the interest Reserve?

   The borrower will accrue interest as funds are disbursed on the loan and it will require a monthly payment to satisfy this accrual.  Because the borrower may be currently paying a mortgage, some loans are set up with an interest, reserve.  The interest payments for the loan are debited from the interest reserve line item.  There are generally enough funds in an Interest Reserve Account to cover all of the Interest payments that may be due during the construction term.  If there is no money left in the Interest Reserve Account the borrower will need to make the interest payments. 

What does the borrower do if an extension of the construction loan term is needed?

   Loans that go beyond the required completion date are technically in default pursuant to the Construction Loan Agreement.  If the loan has gone beyond this required completion date, all loan draws are on hold until an extension is granted.  The borrower needs to contact the lender if his/her term expires and the project is not complete. 

Is there a fee if an extension is needed?

   YES, there is normally a fee associated with a construction term extension.

What is required to roll the construction loan to a permanent loan?

   On Construction-to-permanent loans (aka: one close loans) the borrower should contact the lender at completion to discuss permanent loan options.  Typically, the borrower and the lender agree to the terms of the permanent loan and the borrower must sign an agreement to these terms and return it to the lender.