The lending landscape has changed dramatically in the past four years, and traditional lenders have gone from full speed ahead to full stop on speculative construction and construction-to-permanent loans to builders. Neither of these extremes is prudent nor sustainable, but savvy mortgage brokers can set themselves apart in the coming years and help their clients secure new construction financing with hard-money lenders.
Although conventional lenders’ appetite for this type of product fluctuates with the market, private money has long provided construction financing and continues to do so. Private-money lenders are understandably cautious with new construction loans, as many project further downward pressure on home values. These lenders also are wary of the effect of shadow foreclosure inventory that competes with new homes and is available for 50 cents to 60 cents on the dollar. Although banks generally stay away from new construction loans, private lenders still are willing to fund some projects — if they fit their lending requirements.
There are five key things brokers must keep in mind when seeking new construction loans from hard-money lenders:
- Location: Be sure your lender is comfortable with your project’s geographic location. Typically, a private lender will only underwrite new construction if it can actually kick the dirt.
- The process: Familiarize yourself with the builder’s or subcontractors’ draw process. Individual private lenders can be more liberal and pay a builder directly after a site inspection. This is not the norm, however, and a larger lender will require that a title company be involved and pay the builder and subcontractors directly after lien waivers are received. Contact your local title company to see if it is doing any new construction loans, and if so, familiarize yourself with the lien laws in your state.
- Lot lien: Know whether your lender is comfortable with including some or all of the lot cost in the loan. Ideally, a lender wants a lot to be free and clear or at least subordinated to the first-position private-money deed of trust. Some lenders may fund as much as 70 percent loan-to-value of the appraised value and allow some of the lot cost to be funded into the deal.
- Downpayment requirements: Ask about the requirements for how much of the borrower’s own money must be in the project. On a spec loan to a builder, that may run the gamut from no money down to 10 percent down with either a free-and-clear or subordinated lot. On a construction-to-permanent loan, you can work with the private-money lender for the construction and then with one of your correspondent lenders to do a rate-and-term refinance out of the hard-money loan. The private lender will require a 20 percent nonrefundable deposit, which can be rolled into the takeout loan.
- Rates and fees: Be able to speak in general terms about rates and fees. The typical builder who used bank financing in the past may balk at a six-month loan with a 12 percent interest rate and 4 points, for example, but you must show them the profits they can make on a deal that is consummated, rather than waiting on the sidelines with no funding. For a presold loan, if the end loan costs are rolled into the deal and 5 percent to 10 percent of the project’s equity is allocated for points and fees for the new construction deal, then the clients may be happy they can get a project under way and completed — and often in a shorter time frame than traditional financing.
To receive compensation for their work, brokers must demonstrate that they have brought value to their side of the transaction. For builders or homeowners, you have connected them with a source of funds for their transaction that would be difficult or impossible to close at a bank. For the private lender, you presented a full package with 1003 and supporting financials, so the underwriting of a potentially profitable deal can proceed efficiently and effectively. Work with the lender to have your compensation tied to a front-end closing, monthly payments or when the lender gets paid off. Your compensation will increase or decrease according to how long you are comfortable waiting to get paid.
For brokers who know how to work with private-money lenders on construction projects, there are deals to be made. Set yourself apart from the competition by learning about this potentially valuable niche.