Successfully Financing Your Real Estate Investments: Buyer Financed Construction-to-Perm Loan

A construction-to-perm loan is your second new construction financing option. You are more likely to see this type of financing for single-family home developments. In this situation, the builder is selling you the lot and a home plan he will build for you. You, as the investor, are required to obtain financing to pay for the lot and construction. A construction-to-perm loan provides you with financing during the construction process and once the home is complete, the loan modifies into a permanent end loan.

The advantage to securing your own financing is you need substantially less money out of pocket, at least initially. In this case you are not giving the builder a deposit of 10 percent to 20 percent. Your actual out-of-pocket costs can be exceptionally low. Some lenders may allow you to finance your project by lending you a high percentage of the home’s projected appraised value when completed. This can substantially decrease an investor’s down payment costs.

As an investor with limited funds available, this can provide you with a substantial saving; however, when you obtain your own financing, there are additional risks. The first risk is interest payments. A typical construction loan will have an amount of interest charged by the lending institution to pay for construction costs. Some lending institutions may allow you to roll these interest costs into your overall loan. This will minimize your out-of-pocket exposure on the transaction. However, should the construction period run longer than expected, which happens very frequently, you might incur additional interest costs or lender penalties.

The next risk is additional building and materials costs. If the builder runs into additional costs, such as higher than expected site preparation costs, increased impact fees (taxes), or unexpected increases in building costs, you can be sure these costs will be passed on to you. So although securing your own financing will have lower intial costs, it might be offset by higher carrying costs during construction. Always keep reserved funds in place to allow for the unexpected.

The third risk is responsibility. When you secure the financing for the property, the ultimate responsibility for paying that loan is on your shoulders. The bank expects that loan to be paid no matter what happens. If you select an unscrupulous builder, who either fails to build, or takes far longer and incurs far more costs to build than originally projected, the bank will still hold you accountable for that loan.



Key Advantages to Construction-to-Perm Loan

• Less money out of pocket

• End loan is already in place

• Savings on closing costs



Excerpt taken from Making Hard Cash in a Soft Real Estate Market, Chapter 15, Pages 153-154.

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