Construction loans as well as mortgages use the construction loan property as collateral. This is why various lending institutions restrict the types of construction they will lend money on. They are not only looking at ability to pay, they are also considering what might happen if they are not able to pay. In the event that a homeowner defaults on the loan, the home has to be marketable for resale. Additionally at the end of one year, when your construction loan is transferred to a mortgage loan, your home must appraise for at least the amount of the loan. You will not be able to borrow more than the appraised value of the home, on your mortgage.
Construction Loan Property as Collateral: Restrictions on Property Used as Collateral
It does seem that sometimes lenders interfere with freedom of choice. Whether you want to be your own contractor, or select an unusual style of architecture, include unusual materials, or do a lot of the work yourself, at times lenders will simply refuse to finance an unusual home, or one built under unusual circumstances. While this can be extremely frustrating to prospective home owners, it is important to at least consider the side of the lender.
If there were no restrictions there would be a significant risk that in a year’s time the home may not be complete, or may not be in any sort of habitable condition. The last thing a lender wants is to give a family permission to build their own home, only to find a stack of decaying materials or a twisted gnarly mass of lumber on the lot after one year. They are choosy about which builder you use for the same reason. They are concerned about design as well, because it would be hard, especially in the current market to resell a house that has a style that is unappealing to most people.
If you plan to build your own home, or collect a few friends with experience in construction to help you build it, you will have to prove to the lender that you and your team are capable and experienced enough to complete the project. In the same ways builders with a poor reputation, or builders who have limited experience will have more trouble helping you obtain a loan than an experienced quality builder with a longstanding reputation in the community. If a lender has previous experience with your builder, this may either help or hurt your chance of getting a loan. This is a good reason to ask a few loan officers to recommend builders before you select one.
There was a time when, at least in many locations throughout the country, there was little chance of getting a loan on a home which incorporated unusual materials, techniques or design. Today, after 50 years of struggle, alternative green materials are finally getting a chance to shine. It can still be harder to get a loan, but as lenders see more great results from green building, it will get easier. Unusual design is still hard to sell to a lending institution, but it is possible.
If you have been repeatedly turned down for loans, because lenders will not accept your dream home as is, there are a few things you can do. First you should speak candidly with your loan officer and determine exactly what the problem is. Perhaps with small changes in details your home plan might be acceptable. Possibly there are other techniques or slight changes in materials that would make your home more credible to them. For example if a builder will not fund your adobe home, you could switch your material to insulated concrete for a very similar appearance, and better durability and insulation.
Another option is to get a smaller loan using another type of collateral. In many cases, if you plan to build your own home on your lot, you can borrow money against yours or your parent’s savings or against business property you may own. People with great credit and reputation can often borrow money on their signature, for a period of five or ten years. If your home building plan is modest, and requires a smaller investment, it is quite possible that a bank will lend you money on your signature, or allow you to borrow against other collateral.
The third option is of course to change your plans all together and choose to build a more conventional home. It is hard to give up on your dreams but sometimes, when you have considered all the options, extreme compromise is the only way to make something work.
If you own a lot in a spectacular location or have low cost access to a famous architect, using the property as collateral really works. If the value of the lot alone is more than what you will borrow, for example lakefront or ocean front property, then you will have no problem getting a loan on anything you want to build, because the lot alone is so valuable. Likewise if you put up a large tract of acreage, the lender will be less picky about what you build on it, because the land alone is worth the cost of construction. If your design is superior or especially appealing, then lenders may also be eager to lend on your project. If you plan to build a home of architectural significance for a lower cost than it is worth, the lenders will be very eager to lend the money.
It is understandable that when lending hundreds of thousands of dollars, banks want good collateral and some assurance that this collateral will exist at the end of the year. If your home and land do not appraise for the loan amount, then you, the builder and the lender are all in trouble. There are legal ramifications to this, which will be expensive and difficult to deal with. Therefore the lending institution’s pickiness protects you and the builder as well as the lending institution. Using construction loan property as collateral can make the loan process either easier or more difficult, depending on your plans.