Pay off construction loan with proceeds of selling?

Question

A bit of background... I am a full time Engineer and part time Realtor (1 year experience, 5 transactions), my wife is a freelance architect and holds a degree in construction management. All we want right now is to set ourselves up so I can leave my day job and work full time running our own real estate business. We live in Utah County Utah which is a hot market, at least for selling given the low inventory and huge buyer pool. The challenge is that with so little inventory there is a lot of competition to buy flips if any even come up and few other opportunities.

Our Plan... as mentioned in many places sometimes we have to create out own opportunities. That being said we want to jump in by buying lots and building small single family homes i.e. 1500 sq ft or less simple spec homes. Since I also have a background in carpentry the plan would be to start by building the first one myself. This will allow greater potential for profits and less waiting for contractors since they are hard to come across given to amount of construction going on currently in our market.

The challenge... of course if it was easy everyone would be doing it. So we need to figure out financing. We have roughly $40k - 60k of equity we are freeing up via a HELOC and possibly some 16k of "if-come" in the fall but we are not going to factor that in at this point. Though we have some cash available we need to find some financing fund the construction and lot costs.

My questions... First, is it possible to pay off a construction loan by selling the home immediately after completion before getting a mortgage? Second, If I could convince a Deed transfer for a lot, what would a seller generally want to see in the contract to feel comfortable to do it? And if i did get a deed transfer how would a prospective lender view it? Lastly, What may be some pitfalls I should consider if we go the route of building a small spec home?

Jackson Pontsler · Answer

I don't know how to answer all your last paragraph of questions but I can possibly lead into some insight for the first question: Is it possible to pay off a construction loan.

It depends on how the deal has been structured. If the loan is through the bank and all the contractors have been paid then yes. When you sell the house the title company will seek pay off from all mortgages and/or loans on the property. The money in escrow would go to them and pay them off first then pay your with the proceeds.

If and it requies a lengthy look at your loan agreement. Some construction loans are actually a lien on a property. Then its up to the individual holding the lien they should be contact by the title company to seek pay off where the lender has an option of seeking payoff and it would be paid at closing or say no the lien needs to addressed before the sale can proceed.

I hope this answers your question. By no means is this professional advice. Only pitfalls I've seen from other investors in Salt Lake who use construction loans to rehab a property.

As for deed transfer question I would talk directly with a loan officer at prospective credit unions. They will be more than likely to work with you since it allows them to pitch to you the benefits of using them over their competitors.

William Hochstedler · Answer

Have you talked to the municipality? You are going to have a lot of regulatory issues. Will your city let you build spec homes without being a contractor? Have you factored in impact fees, permit fees, bonding, etc?

Many smaller banks look at the experience of the builder when writing construction loans. Moreover, their construction loan buckets are pretty full right now. So it may be hard to find money.

On the other hand, buying a lot (maybe with seller financing), being an owner builder and occupying it will allow you favorable terms from both the bank and the city. If you sell it without moving in, that may be the last one you do from a permitting standpoint.

But you definitely have a bead on what the market needs. I've been saying Utah could absorb 10,000 of the homes you are talking about. Needless to say almost no one is building them. This may be because bigger profits are still available or it may be that they can't be done profitably at all.

So if you're serious, I'd start by building one of these for yourself which will be much more relaxed from an oversight standpoint. Once you have these relationships you can ask these people how you could do it commercially.

For a lender down there, talk to Bank of American Fork.

Pay off construction loan with proceeds of selling?

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