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   ARTICLE   |   From Scotsman Guide Residential Edition   |   January 2003

Don’t Get Run Over by the Over-Run

Did you know that about 90% of custom homebuyers exceed their budget or don’t finish on time? No 
matter how sharp your borrower’s pencil is, odds are they’ll need to plan for cost overruns and possible construction delays. With your sound advice, there are ways to plan for these unforeseen issues that don’t involve liquidating bank accounts or running up expensive credit cards.

First, be sure of accuracy in the borrower contract, plans and budget. Getting the figures right from the start is critical to a positive construction loan experience. Knowing that borrowers are likely to change their minds about something after signing the contract and breaking ground is very important. Flooring, Kitchens, Colors, Countertops, and

Lighting are common areas where borrowers’ creativity and imagination continue to work, especially as they see their home take shape. 

For the same reason, it’s quite possible that the builder may make recommendations or suggestions leading to changes to the original plan. Worst case, borrowers encounter something that was unexpected and requires them to spend more money. If it’s not covered by their contract, how do they pay for it?

“Structure your construction perm loans to provide maximum financing,” states Dianna Newkirk, M&T Underwriter.  Remember that borrowers can always modify to a lower end loan balance, but can never increase their loan once closed.

Keeping this in mind, qualify your borrowers for more loan. “A higher LTV can often provide additional funds to cover change orders and cost overruns, but this only works when the transaction has upfront equity in terms of borrower cash or appraised value,” said Newkirk. Dianna reminds us, “Don’t forget that borrowers always invest their cash downpayment up front at initial loan closing based on how you structure the LTV.”

Private mortgage insurance is a small price to pay when compared to forking out cash for unanticipated construction costs related to overruns and change orders. Borrowers can drop private mortgage insurance as part of the modification process if their end loan LTV is 80% or less.

Eva Kehr, Construction Lending Manager, recommends discussing overruns and change orders with your borrowers prior to taking the mortgage application.  “If possibvle, encourage builders to provision for inevitable change order costs by including a ‘miscellaneous’ line item in their contract to cover extra expenses,” said kehr.  This presents an easy solution  to a sticky dilemma.

When selecting the correct term--usually six month, nine month and twelve month--consider the construction type and loan size.  Building must be completed and the end loan modified prior to the construction loan expiration date.

Loan extensions can be available, but usually at additional cost.  Use common sense working with borrowers to select the appropriate construction term.  

Today’s construction to perm loan (CTP)  offers more borrower options, choices and flexibility.


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