How to Use Construction Loans to Get 100% Financing on Your Next Deal
Every week someone approaches me that is dying to grow their real estate business. However, they have used all of their cash in property improvements and down-payments.
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With little cash, they seem helpless. However, they are still wanting to continue to grow. There are a million strategies gurus try to sell, however, I’m here to tell you the hard-truth: they rarely work and get-r-done.
There are two primary way’s to get 100% financing and I’m going to focus on the most popular one: construction loans.
It's funny, there are a ton of flippers on BiggerPockets and a ton of people like me who buy distressed properties, fix them-up and then rent them out. Most people don't know exactly how a construction loan works, even though they are very popular types of loans.
For simplicity sake, I'm just going to cover how a construction loan would work if you were building the house for yourself.
A Step by Step Guide to Obtaining a Construction Loan
Before you even approach a bank, please have a deal that you are about to do.
What you need to have before you even approach a bank is:
- Contract for lot
- Construction cost estimates
- Qualifications of the GC (General Contractor)
Once you have all of the available information, have your personal (and/or business) tax returns and all other appropriate financial statements they request.
It is best to have already calculated your mortgage payment on the costs and to show how easy it will be for you to pay this.
A big sticking point with banks is lending 80% to cost or 80% to appraised value. Obviously the latter is preferable. These banks aren’t impossible to find, but you will probably need to do some legwork to find them.
You pay interest only on the outstanding amount though-out the construction period.
After each draw, someone will go out and physically inspect the work has been done. There is usually a nominal fee for this.
The closing of the construction loan is obviously important. Construction loans generally have a 1-year maturity with the understanding that after 1 year, the loan will be closed due to you selling the property (speculative construction) or you closed the loan and the loan is now a mortgage in the secondary market.
If you utilize a construction loan for speculative construction and didn't sell the house within the one-year maturity, you will probably have to take out a new loan under investor terms (20-year amortization, etc).
There are a lot of details I’m sure I left off and as always, every lending institution is different, so be sure to do you due diligence. If you have anything to add I would love to hear about it in the comments.
Photo Credit: photosteve101