Building a better construction loan

With builders finding it increasingly difficult to borrow to buy materials and pay subcontractors, the bet is that more home buyers will be asked to shoulder the burden by taking out construction loans in their own names.

Not that there’s anything wrong with that. Indeed, while there are a few more risks involved -- we’ll get to those -- buyers can obtain construction-to-permanent, or C2P, loans much cheaper than builders, which means the house can probably be built for less money.

Sometimes known as “single-close,” “onetime close” or even “all-in-one” loans, C2P mortgages start out as construction loans and then convert automatically to permanent financing when the house is completed. Since only one loan is involved, there’s only one set of expensive closing costs.

The C2P loans are not new. They have been around for years and are the favored form of financing in the custom home market. But with lenders raising the bar higher for contractors, an increasing number of production builders are expected to turn to the product.

Exact figures are hard to come by, but estimates are that C2P lending accounts for $44.4 billion in construction financing, or about 20% of the $222.1 billion in total construction funding originated last year.

Richard Nirk, the volunteer executive director of the fledgling National Assn. of Residential Construction Lenders in Greenwood Village, Colo., predicts that $45 billion to $50 billion of the current lines of credit supplied to builders will convert to C2P loans during the next three years.

For that to happen, some semblance of order has to be brought to the field. Currently, the various construction-to-perm programs are all over the ballpark, driving builders and their buyers batty with different rules and requirements.

For example, one lender might want to review the builder’s banking references while another may not. Or a lender might want to document a builder’s licenses, check over his lien releases or his “draw” or payment schedule or even take a peek at his gross sales, but others may not.

A big part of C2P lending, perhaps 60%, still involves contractors who erect one-of-a-kind houses. But Nirk, who built Chase Manhattan Mortgage Corp.’s construction-lending division into a powerhouse before becoming a consultant, said production builders are finally starting to catch on to the benefits that C2P loans offer.

“Builders are just beginning to understand this product and how to leverage it,” he said.

It is the small builders, who produce 3 of every 4 new houses, that are driving the C2P market.

“Big builders can always borrow cheap money, but little guys like me can’t,” said Jim Janco, who started Montgomery Homes in Denver early last year after spending the previous 20 years as an executive at other building firms. He had more difficulty than he expected, given his construction experience, in lining up financing.

Janco, chairman of the Denver Home Builder Assn.’s sales and marketing council, likes construction-to-perm loans because he can price his houses more reasonably.

Because most buyers can obtain a construction loan at about 3 percentage points less than can the typical builder, the savings on a $200,000 house over a normal 180-day building sequence is about $3,000. Consequently, he can knock that amount off his asking price.

There’s also $2,000 to $3,000 in savings because there’s no longer two closings, one when the builder takes out the construction loan and the other when the buyer takes out the end mortgage.

Most of all, Janco likes the fact that with C2P loans he can use someone else’s money to build his houses. “I get the best of both worlds. I can build and it doesn’t cost me a dime. It frees up my line of credit to put up spec houses if I want and keep my [workers] busy.”

It’s not so much that funding is more costly of late, said James Owen, executive director of the Medina (Ohio) County Home Builders Assn. Rather, builders are being “squeezed” by lenders who are requiring more documentation and otherwise forcing builder-borrowers to jump through more hoops.

And what about drawbacks for the home buyer using C2P loans?

With normal financing, if you lose your job, suffer a medical catastrophe or just have a change of heart, you can back out of the sale and all you’ll lose is the deposit you gave the builder. But with single-close loans, there’s no changing your mind, for any reason, after construction starts

In addition, you should be careful in choosing your contractor. Not all lenders have checks and balances in place to protect their interests or yours. But even if your lender examines the builder’s references and bank accounts, it’s your neck on the line if something goes haywire.

Finally, some lenders aren’t doing enough to make sure the contractor pays his bills. Therefore, it’s up to you to be certain that signed releases are collected from subcontractors and suppliers every time the builder asks for money. Otherwise, you could be hit with a mechanics lien.

In fact, you’d be wise to make sure the checks the builder writes have been deposited and have cleared before going on to the next payment. It’s only after the money becomes “good funds” in this manner that the right to file a lien is extinguished.

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Group raises loans’ profile

The National Assn. of Residential Construction Lenders was formed 16 months ago to bring order to the highly fragmented construction-to-permanent, or C2P, mortgage market.

Founding members include such mortgage heavyweights as Washington Mutual, Countrywide Financial, Waterfield Financial, Chase Manhattan and Fannie Mae. Today, the group also includes CitiMortgage and IndyMac Bank.

The group was created to improve awareness of the product, increase its availability, improve customer service, decrease risk and improve profitability. It is also developing standards for the benefit of builders, lenders and buyers.

As a first step, the 50-member group is creating a standardized contractor questionnaire that C2P lenders can use to help evaluate builders or that builders can have ready for buyers who are about to apply for financing.

Also on the association’s agenda is the creation of standardized documentation for house plans and projects, for home inspectors and for contracts, including draw format, disbursement alternatives and mechanics lien documentation.

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Lew Sichelman is a syndicated real estate columnist. He can be contacted via e-mail at LSichelman@aol.com. Distributed by United Feature Syndicate.