How To Get A Construction Loan In California

Financing of Land

If you are planning to buy a piece of land and then build your dream home, getting a construction loan from the bank may be the right direction to take. A common misconception among many homebuyers is that it is not possible to get a loan to buy a piece of land. This is not the case!

The basic parameters when it comes to lot loans (also known as home loans) are as follows:

• The piece of land can be up to 10acres
• Conventional mortgage financing
• 3/1 Adjustable-Rate Mortgage (which means that the initial interest rate is fixed for a period of time. With the US Bank, the rate is fixed for 3 years then it becomes variable after that. Homebuyers can therefore come back and refinance the loan again)
• Loan sizes of up to $300,000 (there are exceptions for higher loan sizes, please consult your loan officer regarding this)

What do banks look for when financing land?

The bank does an appraisal and it comes back and tells the buyer whether the lot is an improved lot or an unimproved lot. Unimproved means it does not have access to electricity/ water. Improved means the lot has access to city water, county water, and electricity. If the lot happens to be unimproved, the bank lowers the loan to value by 5% and the homeowner would have to pay the additional expense of providing city utilities to the property.

What is the loan-to-value ratio on a piece of land?

The larger the value of the loan the higher the down payment but there’s still a lot of factors that the bank considers. For example if the loan size is between $300,000- $400,000 that would be 80% of loan to value.

In terms of payments, once you get the lot loan, you will be paying principal and interest the moment you close. On the piece of land, you make the payments on the construction loan.

 

What should potential home buyers look for when looking for land

There are certain factors that need to be considered by home buyers before deciding to place an offer to buy a piece of land. The main reason why you should consider these factors is because they will help you establish whether the piece of land is buildable or not.

We interviewed Lora Fisher, who is a Loan Officer at the U.S Bank and she stressed on doing a CSI- Client Scene Investigation. This can be performed by doing a thorough investigation on the property first of all by speaking to the listing agent.

Some of the questions that you should ask the listing agent include:

• Are there any issues with the land that you should be aware of?
• Why is the owner selling the land?
• What are the ground conditions like? Can you construct a house on the land?
• Are there existing planning permissions in place?
• Has someone already gotten building permits and decided not to build?
• What’s the history of the property?

Also, speak to a contractor and ask them to take a look at the property to determine if it is buildable. It is also advisable to visit the city or county offices and get as much information on the land as possible.

Recommended Inspections in land transactions

It is common for a loan closing to take time to close due to the need for additional environmental testing by the bank. The bank will carry out due diligence on the parcel of land by doing soil inspections & percolation tests (which measures how quickly the soil drains) among other tests. The bank will not accept your property as collateral until these test results are out.  

Would the bank ever lend on land that is not buildable?

The bank is very keen on doing the tests mentioned above to determine whether the land is buildable or not. In special circumstances, for example, the bank will not loan on a parcel of land that used to have a fire station.

That is why the importance of due diligence cannot be stressed enough! Remember, It is still your money so don’t expect the bank to do all the work for you. It is also advisable for the buyer to always get home insurance-  it’s not a requirement but is good to have.

Types of interests when financing land

Interest from the U.S Bank is around 5% and that’s the rate that has been there for the past 2-3 years even with the ups and downs in economic performance. 

The escrow typically can close in 30 days! But on average for many banks, it can close between 30 - 45 days depending on whether all the appraisals and tests have to be done prior.

 

Construction loan process

The process can be broken down as follows; 

• you find the piece of land
• you get financing, 
• you start going through the permitting process where you get all the permit forms you need and approvals from the city

Typically the loan process takes about 3- 4months from beginning to end. Unlike a regular mortgage, the lot loan is detail-oriented and that’s why it takes that long. The bank also tries to time the process so that as soon as you get the permits then you’re not too far from closing the deal. 

 

At what point does the lot loan get paid off?

Once you have the lot loan, the bank goes back and takes a look at the construction loan. Construction loans from the U.S Bank are single close construction loans which means that the bank has to be in the first position, which means that the bank pays off any pre-existing loans on the property.

If you have a half-million-dollar lot, and half million dollars in construction, the all-in expense would be 1 million dollars, the bank would go up to 80% financing as the baseline so in this case 800k of which 300k goes straight away to pay off the bank and the remaining balance would be used for the construction of the property.

 

Expected approval time on loans

On average, the turnaround is between 1- 3 years. However, this also depends on the location of the property. If you're on the Coast it can take up to 6 months to get permits alone which takes a shorter duration in cities where there is more housing development. 

 

Process of Construction Loans

The bank uses a fund control company to disburse the funds. It’s important to ensure that when vetting the builder there's no history of lawsuits because, in essence, all the funds go to that particular company. The banks will do a monthly draw on the construction loan using descriptions of cost breakdown.

Once the builder decides to ask for a draw request it takes about 40 to 72 hours to get the funds disbursed.

 

Advice when looking for a contractor

Below are some guidelines for choosing a reputable contractor

• Use Google/ any search engine. This is the first step in doing due diligence. What to look for when doing desktop research may include- litigation history and bankruptcies
• Look for the type of house you want to build, then get referrals from the household or householder
• Talk to old references- creating a list of names of customers whose projects are similar to yours then asking important questions about how the contractor responded when things didn’t go right, how easy it was to work with the contractor, etc.
• Find out how many homes the contractor is working on currently before they take on your project. This is important information to have depending on the kind of relationship you want to establish with your contractor. If he/ she is working on more than 4-5 projects, then it’s possible that they will use other subcontractors. Keep in mind that you always want to make sure that top-notch contractors handle each part of your project. 
• Review the contractor’s basic experience by finding out how long the construction company has been in business and whether they have worked on homes similar to yours.

Timeline For A Construction Project

The timeline of a construction project largely depends on the size of the project and the contractor you work with. For the majority of new homes you probably are looking at between 12 to 18 months. However, always factor in delays and add a couple of months (3-4 months) from when the contractor says the construction will have been completed. 

How does the payment for construction loans work?
Just like any other mortgage you owe it every single month during the course of construction, it'll be Interest-only and then after the house is completed it converts automatically to Principal + Interest. 

Upgrading Properties - Remodeling Loans

The U.S bank can do remodel loans too and that’s similar to a construction loan. There are options for remodeling or if you're looking to buy a house and you think the house would be perfect but it needs to be a little bit bigger the bank can come in, buy the house, get your plans and permits, and make the vision of your custom house come to life. 

 

What happens to the construction loan after a project is done

After the project is done, there are two main products- either a 30-year fixed or a 10-year fixed ARM. The most popular is our  30-year fixed ARM. One of the best things about getting your construction loan from the U.S Bank is that there are no prepayment penalties after you're done with the construction.

 

What’s cheaper: building a house or buying a house?

Technically, it would be cheaper to build a house but where the caveats are-  it goes all the way back to experience,  knowledge, cost overruns there are all those factors and time. You really have to dedicate a lot of time when building your house and it may seem like a full-time job for the homeowner.  You will want to dedicate the time the money and the energy to build a house and for many people, it is worth it because they can build exactly what they want, but it's not for everyone!

 

How is the final value of the property estimated?

The bank will use the description of materials and cost breakdown. The bank also uses a licensed appraiser to determine the current price of a home after construction. What the appraisers will consider are- the square footage of the home, the size of the lot, how many bedrooms and bathrooms the home has as well as any extras such as a pool or shed.

In doing the appraisal, the appraiser is going to look at comparables in terms of what houses have been built recently that have been sold and then what have those gone for.

Having cash on the side just in case there are cost overruns or having access to cash is going to be critically important when you're looking at a construction loan. It is also wise to pay a little bit extra for an experienced contractor as opposed to going with the cheapest one as this will save you time and money in the long run.

 

Has covid affected construction lot loans?

Due to Covid, the process of getting construction loans has become slower and there are fewer houses being built. Some small banks have even stopped doing construction loans but the U.S Bank has stuck with it. Being one of the top 5 banks in the U.S helps because they have a lot of financial muscle behind them so it's a very competitive product for the bank and they are very committed to providing it.

 

Final message

Thank you to our guests- Lora Fisher and her partner Anish for joining us on this interview. Apply now for a lot loan by visiting www.usbank.com or call 805-245-9678.

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