Construction Loan contract question - deposit required?

pbx2_gwApril 4, 2012

We are having built our first custom home.

Currently, In the middle of contract negotiation & one item that we are not versed on is that the builder has asked for a 5% deposit towards the construction phase up front.

*** The exact quote from the builder was:

Yes, typically you will own the lot outright and have placed a deposit on the construction contract before we begin. For construction/perm loans, this provides the bank with additional security (holding a half-built house is even worse for a bank than holding a completed home). If your bank is OK with a different arrangement, I can be flexible."

We would be putting essentially 20% down already by purchasing the land from the builder & borrowing the other 80% of the total package cost from the bank.

Just not sure when this 5% comes into play when we are settling with a one time close & the 20% would be provided to the lender/builder then to use at they please.

QUESTIONS:

1) This 5% requirement would put things @ 25% no?

or

2) Are we thinking about this incorrectly & that this is still part of our 20% down...

3) Is this just a case of the builder wanting some of that down payment up front (during contract phase) vs. getting at settlement a couple of month down the road all in a lump sum?

or

4) Is he really tacking on 5% on top of our 20% downpayment?

5)Is this industry practice or New banking guidelines in the new home environment?

Thanks in advance for any guidance & insights!

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andi_k

Here's how ours worked...

We owned the lot outright, and it was approx 25% of our LTV when the appraisal came in for the land + estimated finish of home. So, essentially, the value of the land could have been considered our "20%" requirement for the bank. But, we also had another 100K that we wanted to put down.

The builder only asked for 10K upfront. Not anywhere near 5%.

When we closed on the loan, we gave the 100K to the bank to 'hold' and it was part of the first draw they made. The first payment to the builder was about 150K. But, the bank applied the 10K down payment, then our 100K down payment towards the 150K, and only really gave us 40k. Everything after that is pure bank form our loan.

So the 5% should not be in addition to the 20%. But, know that the land value should apply towards your LTV as well.

hope that helps

    Bookmark   April 4, 2012 at 2:09PM
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tooskinneejs

It is not uncommon for construction contracts to call for 5% of construction costs payable upon execution of the construction contract. We paid this for our build. We did not, however, buy our land from the builder.

Whether your builder is asking for a 5% down payment or a 25% down payment depends on whether your purchase of the land will be final (not contingent on the build). If it is final, I would not consider that part of a down payment on construction - I would consider that the separate purchase of land.

    Bookmark   April 4, 2012 at 3:17PM
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pbx2_gw

@ Andi_K - thank you for illustrating your example. It seems quite logical.

@ tooskinneejs - our thought process is we are buying both land & construction from the same person - we are thinking the 20% is part of the entire package = land + build.

So to us at settlement - where it is a one time CP close - we are putting down for the ENTIRE package - so where the 20% gets allocated is more or less irrelevant.

What is relevant is:
1) The cash outlay for dp + closing cost are kept to a minimum by our design
2) If 20% is used by the builder at all initially - for construction dispersement vs. using Bank funds (cost us interest).

Back to the original question: is this 5% an additional up front charge?

From what I am seeing from all your comments - it is customary from an industry standpoint but it is not really bank/lender required. It really is how you structure the financing & how much equity you eventually count towards the final product.

ie. for our situation - the 5% could be part of the 20% dp or it could be part of a 25% dp.

    Bookmark   April 4, 2012 at 3:48PM
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auroraborelis

I assume you are taking out the construction loan from a bank, which will then make payments to the builder?

If so, the 5% should come from the construction loan itself.

    Bookmark   April 4, 2012 at 5:11PM
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bevangel_i_h8_h0uzz

I have issues with the EXPLANATION your builder tried to give you regarding the 5% deposit he is asking you to pay to him. He says this provides the bank with extra security... HUH?

How can your giving extra money to the builder possibly make the bank more secure???? Yes, banks want you to have skin in the game but I suspect that bank would much rather have that extra 5% of yours in a deposit account in their bank ready to pay out to builder once he has earned it than in builder's pocket before builder has even broken ground. And, it actually sounds like the 5% is going to have to come out of your loan amount rather than out of your pocket now. If so, what builder is actually asking for is a 5% draw from the bank before he ever does any work. NO WAY!

The last thing banker's want is for builders to get any of bank's money BEFORE they earn it. Getting money upfront (before work is done) is how shyster builders operate. They are the ones who then disappear leaving you with a half-built house and not enough money left in the bank to finish it...which often forces the homeowner to walk away leaving bank owning the half-built home.

If builder had said something like: "the 20% down is to purchase the land. You will then own it outright and I will give you the deed for it immediately. That means that, if you then decided you wanted to, you could walk away from me and go find someone else to build your house on the land. So I want an additional 5% deposit to ensure that you'll stay with me and let me build your house because otherwise I don't want to sell you the land." Well, that would have made sense and at least sounded honest. (That is, assuming the land without a house is actually worth that 20% and you could build the house you want for the remaining 80%.)

But "pay me an additional 5% because it will give the bank more security" is, IMHO, pure flim-flam! And, if builder will attempt to flim-flam you at this point, he'll do the same thing repeatedly over-and-over again as the work progresses.

Frankly, this is a red flag that should make you wonder if you even want to get into a contract with this guy at all. At the very least, ask your builder - in the presence of your banker - to explain to you EXACTLY how your putting more money into buider's pocket before he actually does any work for you is somehow going to make banker feel more secure. And then ask your banker if he agrees with builder's explanation.

    Bookmark   April 4, 2012 at 5:30PM
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pbx2_gw

@ Laura12 & @ bevangel - Thank you both for your responses & insights.

We met with the builder again & to clarify this matter & it "appears" he mis-understood his initial response to our question regarding the 5% deposit & the timing. Only 2nd house besides model & another couple starting the same time we are.

Fact:
1) We are purchasing his land & that equates to 18% equity in the total project price (out of 20% down payment).

2) The remaining 2% could be considered a "deposit" - but like I made the builder realize - we are bringing the check for the 20% down payment to the one time close settlement.

He gets paid for the land & the remaining is up to him & the bank on timing of dispersement.

I get the feeling the builder just wanted to make sure we all were covered if appraisal comes back lower than total cost in these current times. He didn't want to lose the sale based on us being on edge for just 20% with no cushion.

So what remains is just getting the language down on paper correctly & we are on our way to signing.

    Bookmark   April 9, 2012 at 10:00AM
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