In my previous article, I discussed the primary considerations when choosing between new construction home purchases versus doing construction yourself. Of course we merely scratched the surface, and a brief article cannot do the matter justice, nor convey the inherent risks involved in either situation. Let’s face it, conventional mortgages are complicated and boring enough on their own – articles about construction financing can be even worse. That said, as evident by the myriad of dumpsters and porta-potties seen throughout the neighborhood, this is a very timely and important topic.
For this article, we will focus our attention on new home purchase that will ultimately need major construction. There are several initial factors that need to be considered. First and foremost, the home needs to be purchased in a timely manner. From my experience, a home that is going to be considerably renovated, or often knocked down entirely, will be looking for someone to complete the transaction as quickly as possible. In such a scenario, it is likely that the seller will not have the time or interest in delaying a closing while a potential buyer brings in architects and contractors for estimates and proposals.
There are several approaches to handling a situation like this. I will discuss the most common, but there are additional options beyond those detailed herein. The first option would be to purchase the house as-is with a traditional mortgage, fully disclosing to the mortgage lender your intent to refinance the loan once construction financing is in place. Some banks might have clauses or consequences in doing such a thing, so it should be disclosed from the start so that you are aware of the variables. The section option would be to find a “Contract through Construction” loan where a bank or lender, such as Approved Funding, is able to finance both the contract (acquisition) as well as the construction in one loan from the start. These types of loans might be very suitable for the prepared individuals who know their end result from the outset. These buyers will have their plans, builder, budget and agreements in place in a timely manner, and they know the seller will allow the needed timeline to accommodate their construction – acquisition loan.
Within that second option exists several construction loan products that can have a significant impact on your overall strategy. One option is where the bank would offer a temporary construction loan, typically for 12-18 months that would need to be refinanced at the earlier of the completion of the loan term or the construction. Alternatively, that same short-term loan might convert into a permanent loan once the construction is complete – with different rates and terms from the initial construction period. Additionally, there is a hybrid construction-to-permanent loan that continues as a normal loan after the construction period is completed.
Each of the above options has their advantages and disadvantages. I was recently contacted by someone whose construction loan was ending, but his construction was not complete. He was faced with severe penalties if he couldn’t payoff (refinance) the construction loan when it was due. He was already on extension with the bank, and still had several months of work to be completed before his deadline in six weeks. He was really in a catch-22 and unfortunately the bank he went with did him a disservice by structuring the loan for him the way they did. Intentional, I think not, but that is why it is so important to get the proper full-picture guidance by a competent and knowledgeable agent who can unbiasedly offer the good, the bad, and the worst-case scenario options which are likely to happen in construction lending. There is so much more to say … Shout out to Chaim Shulman (without the “c”)!
By Shmuel Shayowitz
Shmuel Shayowitz (NMLS#19871) is President and Chief Lending Officer at Approved Funding, a privately held local mortgage banker and direct lender. Approved Funding is a mortgage company offering competitive interest rates as well specialty niche programs on all types of Residential and Commercial properties. Shmuel has over 20 years of industry experience including licenses and certifications as certified mortgage underwriter, residential review appraiser, licensed real estate agent, and direct FHA specialized underwriter. He can be reached via email at
