Construction Loans differ from regular purchase money or refinance home mortgages in the way the loan amount is calculated and the way it is structured.
The main components of a construction loan are:
- Soft costs: consisting of architectural plans, engineering and permit fees.
- Hard costs: which are all the actual physical costs of construction.
- Closing costs: consisting of origination and lender fees, title, and closing fees.
- Inspection feed.
- Reserves: consisting of interest reserve and contingency reserve.
- Existing: lot pays off.
Regular purchase money or refinance mortgages are based on Loan to Value Ratio (LTV). Whereas, construction loans are based on Loan to Value Ratio as well as Loan to Cost Ratio. What makes the whole thing more complex is the fact that the way these numbers are calculated or the ways the numbers are put together differ from one investor to the next?
In fact the calculations get complex enough that most loan officers in most lending institutions dont even know how to calculate a loan amount. This is what results in last minute unpleasant surprises.
The problem that most applicants of construction loans face is when at the 11th hour they get a call informing them of the final loan amount as calculated by an underwriter which may or may not be sufficient to meet the borrowers needs.