Construction to perm loan

[Ray Miller]

I have two of these in the works here now. I am watching them. The bank contacted me about 75% through the consturction and wanted to know if the value was still there. At that time it was, but I noted to the bank that the area marketing times were now longer and was what I felt starting to show a decline for the larger homes not on water. Now here it is six months later and the larger homes new not on water are indecline in value with a year or more on the market.

Talking with the bankers at present they are going to convert the construction loan to a 30 year fixed. As the credit scores are high for the borrowers. There only other option is to not make the loan, let the borrower see if they can find a loan, if they don't then foreclose on the two homes. They want to try and advoid the mess and are going to take the gamble that the home owners will pay off the note. In most case they will because they farm in the area, the price of row crops and dairy are at an all time high.

City people have slowed up moving out to the rutal areas and driving into Madison for work. High end second homes and recreational land are still up some what, but longer marketing times now and not increasing in price. I would say that submarket is stable at present.

 

[Marcia Langley]

Thanks, Joyce. So as long as the buyer does not default everything goes as planned. It's just that the borrower is upside down and the bank is nervous.

There only other option is to not make the loan, let the borrower see if they can find a loan, if they don't then foreclose on the two homes. They want to try and advoid the mess and are going to take the gamble that the home owners will pay off the note.

Ray,

I don't see how the lender can just 'opt' not to make the loan. If the borrower still wants it and is willing to make the payments, how can the bank just decide to foreclose?

It would seem to me that the borrower is the only one that can opt to walk away and suffer the hit to his credit.

 

[Richard Carlsen]

Marcia;

You have to look at the construction loan and the end mortgage as two different lending transactions. They are two different lending processes.

The construction loan is made based on the HC condition that the house is completed per plans and specs. Oft times it is an interest only loan with a balloon clause set somewhere around 1 year with extensions possible. The mortgage taken on this loan is not sold to the secondary market but is done as a portfolio loan. Often, certain banks will specialize in this type of loan, overseeing the construction draws, sworn documents, etc.

The end mortgage is for your typical loan such as used in a sale or refi. It is originated when the house is completed. I'm not sure if this requires a separate signing or is a "rollover" type origination but it is a separate loan that is normally done to secondary market guidelines.

The reason the bank can opt out or change the terms of the end mortgage is because of market change from ground breaking to completion. The borrower goes into a construction loan agreement, understanding that the construction will be per the plans and specs provided and that the value will be at a value of at least that of the construction appraisal.

When the market goes south during the construction phase, the lender has no alternative but to change the terms of the end mortgage to comply with the secondary market requirements as the end mortgage is the loan that will be sold.

 

[Marcia Langley]

So the bank can change the terms, for example, to only permanent-loan an amount more in line with the recent value even if they have already paid out the larger amount on the construction loan.

Then if the borrower can't pay the bank back for the difference, that in itself is considered a default on the borrowers part on the construction loan?

 

[Richard Carlsen]

Yep.

The bank, using the secondary market, cannot a loan based on a value from 18 months before before construction began. That is the reason for the request for recertification of values that we get. We essentially say that the value opined then is valid today. With that recert, the construction loan can be rolled into an end loan.

However, if values go down during that period of construction and the original value or greater cannot recertified, then the bank must make its lending consideration based on the current appraisal and the lending rules and laws that they operate under.

This is problem that all HO's face, not just new construction owners. If someone buys a house with 100% financing, and 2 years later the market has declined by 10%, when the seller is only able to sell the house for 90% of what they paid 2 years before, that does not mean that the bank has to reduce the amount due on the original loan to what the seller can afford to pay. They can, in lieu of foreclosure, do just that (short sale) but they do not have to do it. By the same token, the bank is not and legally cannot go into a loan secured by a mortgage that is in a short position at the beginning.

As I said in my original post, I seriously doubt that a doctor with an 800 credit score cannot be accommodated in some way. At the same time, the doctor must make some concessions on the terms of the loan necessitated by the declining market.

 

[Jim Buckner]

In real life the bank will simply let the doc take out a side note to make the deal work for him and allow the end loan to be sold in the secondary market with the amended value. The bank wants to keep this customer happy and will accomodate his needs.

 

[Marcia Langley]

Thanks all for my education.

 

[Pat Butler]

The bank may try and bluff by telling this guy to find some financing elsewhere, but meanwhile I'm sure they'll keep the construction loan in place and keep taking his money.

All of this comes down to crappy undewriting. People shouldn't be building new houses without at least 20-30% down payment. The market should swing that much during the time of construction and that's the whole idea behind a down payment.

Around here at least, the lender requires the underlying land to be paid in full prior to granting a construction loan. Land values are high enough that the land value by itself usually ends up being at least 20-30% of the total value.

 

[Pamela Crowley (Florida)]

Bank shouldn't have ordered the new appraisal (update). Bet the Doc would have moved in and made the payments.

 

[Mike Boyd]

Upon doing the final inspection to verify that all construction is complete per the plans and specs, another title search is generally done to clear up any lien issues, etc., and the construction loan is then automatically converted to the permanent one just like any other.

Not always. Many construction loans are all due and payable upon completion of the house. (although the ones I have seen allow a grace period of 1 year to obtain a permanent loan) Construction loans for homes built on spec are always due on completion as the loan has been taken out in the builder's name, not the buyer's. But, in this case, it appears the construction loan was in the name of buyer. I just completed the 1004D for a construction loan taken out in September, 2006. Before accepting the 1004D order, I informed the mortgage broker that most lenders will want an "update" or a new appraisal. He said, not this one and to just certify that the house is completed and built according to the plans and specifications. When you check that box on the 1004D form, nothing is asked about the current market or of the current value. I MAY be wrong, but in this market, I expect the lender to kick it back to the broker and ask for a new appraisal.