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Hi MM,

I am contemplating having a custom home built... The builder wants 5% earnest money up front plus he wants me to obtain a construction perm....

On the service it appears that I would be vulnerable, especially since I am paying the interest on each draw. If the house gets delayed during construction, this interest could add up quickly. Correct me if I'm wrong, but wouldn't it be in my best interest to get this home built as soon as possible to avoid interest? Since the builder wants 5 % up front, when should I expect him to ask for the first draw?

A construction-perm loan is a really nice program designed to eliminate the need for two seperate loans and the subsequent doubling of closing costs.

In days of old if you wanted to build a new home you had to finance in two stages;

1) The higher-risk construction financing to obtain or pay off the costs of the raw land, and pay the development costs of building the structure until complete. Because this was a loan on an unestablished collateral, the rates would be much higher, and the loan period very short. Once the job was complete, because the collateral is now materially different from how it began, occupiable, and recognized as less risky, you needed to create a whole new long-term loan...

2) So you would refinance into a long-term, lower interest rate regular residential home mortgage.

When doing this little dance you had to pay the ensuing closing costs on the financing twice.

Today's construction-permanent combination loan is considered a "niche" product and only a relatively few lenders offer it, but for those that do it becomes combined as follows;

1) The loan is made to cover the cost of the raw land AND the necessary costs (according to the contractors bid and contract) to create the structure,

2) the first phase is either 3, 6, 9, or 12 months... depending on the complexity of the project,

3) During the pre-set construction phase there are no out-of-pocket payment requirements of the borrower... what would have been the monthly interest payments are calculated as draws against the principal and rolled back into the loan... this is calculated and known in advance, and is advantageous to the borrower in that available-cash is always a crucial issue during the construction phase,

4) The builder is required to be "approved" by the lender (since the builder is creating the collateral the lender is giving money against). If this builder hasn't been backed by this particular lender before, the builder must submit an extensive approval package, including their personal and business credit reports, prior jobs and references, bonding, resumes, etc. etc.

5) During the set construction phase the lender pays a specified draw to the builder at the end of each month according to the builder's accepted bids for the work, and according to the amount of work that is complete according to the lender's inspectors. Only the work completed is paid for (and debited into your loan) at that time,

6) The builder is "on the hook" contractually to you (and by proxy to the lender) for timely completion and execution. If the builder causes delays, you would certainly be in a vulnerable position and would have reason for compensation. This is why the bonding and insurance of the builder is crucial. the lender will make sure they cover their own ass.. you need to do the same.

7) At the end of the specified construction phase (3, 6, 9, or 12 months), the interest-only, self-paying period of the loan expires, and it automatically converts to however much time is remaining for either a regular 30 year or 15 year loan (so, either 29 year, 29 years 3 months, 29 years 6 months.... etc... you get it?) at a relatively standard prevailing rate of interest.

I say "relatively prevailing" because it will be somewhat higher than a vanilla 30 year fixed because it is blending the normally higher-risk higher-rate 6 month period into the overall lower-risk 30 year period, coming out with a slightly higher 29 1/2 year interest rate.

8) This "conversion" to a new loan takes no new title work, attorney work, escrow work, appraisal work, or loan officer work (et. al.) so the 2nd "closing" costs nothing extra. The construction-perm. loan overall takes a LOT more work than a standard, vanilla loan... so you can typically expect origination costs to run 1 1/2 points to 2 points... and the costs for appraisals are higher because you need an initial appraisal and an additional monthly builder's inspection (mini-appraisal)... but overall the combined program saves the new home builder/buyer thousands of dollars in unnecessarily duplicated services.

Am I right in assuming that I need a real estate attorney to represent me, or will the attorney representing the lending institution suffice?

Whenever in doubt, it's never WRONG to have your own attorney represent your interests. Many many people, however, arrange construction-permanent loans without an attorney (which is not to say that their numbers make doing so safer.)

Again... the lender will absolutely make sure their butt is fully covered. It always makes sense that you do the same.

Hope that's helpful!
Dave Donhoff
Lic. Mortgage Broker
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