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CHAPTER 9
CONSTRUCTION LENDING
OBJECTIVES OF CHAPTER
Upon successful completion of this chapter, students should be able to:
Understand the importance of housing starts and construction
lending to the entire economy.
Explain which lenders make these loans and why they offer these
loans.
Discuss the process of advancing funds for a construction loan.
Examine the similarities and differences between construction
loans and permanent financing.
Explain the process of originating a construction loan.
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I. Introduction to Construction Lending
A. Housing starts
B. Multiplier effect
C. Who does construction loans?
D. Why lenders do construction loans
II. Construction Lending Basics
A. Advances or draws
B. Collateral
C. Construction loan versus permanent loan
D. Term
E. Phase of Disbursements
F. Schedule of disbursements
G. Repayment
H. Who is the General Contractor?
III. Construction Loan Programs
A. Construction only – with two closings
B. Construction/Permanent – with one closing
C. Builder Speculation home Loans
D. Construction loans for Rehabilitation
E. Drawbacks for Lenders
F. Construction Loan Management
G. Mechanics Liens
H. Operational Issues
IV. Construction Loan Origination
A. Application
B. Cash Flow Analysis
C. Processing
D. Underwriting
1. Cost to Construct
2. Cash Flow Analysis
3. Property Appraisal
E. Closing
F. Application Process—Builder
G. Loan Administration and Funding
Teaching Tips
How does residential construction affect the local
economy?
What are the main differences between a residential
construction loan and permanent financing?
Describe the effect the local economy and interest
rates on the construction industry and weight them
against each other in looking into the future.
What are the main factors the lender will look at
when reviewing an application for construction
lending?
If the interest rate was lower at one lender for a
“construction only” loan and higher for a
construction to permanent loan, how would you
explain the differences to a potential applicant and
help them make a decision where to apply. Discuss
the importance of the applicant, the property and the
builder and what you would look at when deciding
the risk factor of each.
How would you advise a potential borrower to
prepare themselves to apply for a construction loan?
If the borrower is having trouble with
disbursements from the lender and the money is not
flowing fast enough, what should the loan officer do
to help?
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SUGGESTED TRUE/FALSE QUIZ
1. Since 2000, the average number of new single-family housing
starts has been less volatile than in the prior decade.
2. Construction lending is inherently different from permanent
financing because of the way funds are disbursed
3. The typical construction loan is for 90 days
4. The most common method for closing construction loans is to
close both the construction loan and the permanent loan at the
same time.
5. The mechanic’s lien in most states takes priority over the first
mortgage – even if it is filed after loan closing of the first.
6. Appraisals for new construction are completed using plans and
specifications.
7. If the applicant for a construction loan is the builder the mortgage
lender will not require a credit check.
8. Before issuing the final advance the construction lender must
obtain a certificate of occupancy.
9. Many lenders will not make a construction loan to a general
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contractor who will be the homeowner.
10. All construction lenders can lend up to 95 percent of the cost of
construction of a single-family home.
MULTIPLE CHOICE QUESTIONS. More than one answer may be
correct – select all correct answers. (Correct answers are italicized.)
1. Over the past fifteen years what has been the average annual starts for
single-family construction?
a. 200,000
2. The repayment of a construction loan is normally accomplished
through:
a. gift from a third party
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3. The amount of a construction loan is normally paid out:
a. on an amortized basis
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4. In almost all situations, the maximum loan to value for a construction
loans is:
a. 70 percent
5. Any person who performs work on a home and is not paid may file a:
d. builder’s lien
ANSWERS TO ORAL DISCUSSION POINTS
The discussion points at the end of each chapter are intended for oral
discussion in class. Suggested answers/points to emphasize for the
questions are found below.
1. Why do lenders participate in residential construction lending?
ANSWER: In order to earn a higher interest rate and provide excellent
fee income which, given the short maturity of one year or less, is usually
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2. How are construction loans structured?
ANSWER: By establishing the value of the improvements and then
advancing funds in step with progress of the construction. Term is brief –
3. What are the benefits and drawbacks for both the lender and borrower in
using a “two closing” loan products? A “one closing”?
ANSWER: The two closing adds a repayment phase similar to
permanent financing, with principal and interest amortization over a 15 to
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4. How do construction loans differ from first mortgage, home improvement or
home equity loans?
ANSWER; A construction loan is a short-term interim or temporary
loan generally 6 to 12 months that is designed for construction purposes.
5. What should a lender review when managing a construction loan portfolio?
ANSWER: The lender should be very concerned with the phases of
disbursement of funds. Many construction lenders advance less than 20
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6. Explain the construction and funding process
ANSWER: Funds for construction loans are disbursed in installments
according to a pre arranged schedule. The schedule is typically
provided by the builder, outlines the phases of construction and at
7. What is the difference between “purchase price” and “cost to construct” for
new construction properties?
ANSWER: When dealing with newly constructed residential property, the
“purchase price” typically means the seller is a builder who just completed
the property (or will do so before closing). The applicant is NOT involved in
“Cost to construct” typically is used in construction lending to reflect all
those costs and steps beyond the actual structure of the home which are
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