Many people are confused about the difference between a construction loan and a renovation loan, as are some loan officers at many lending institutions.
In simple terms…
A construction loan is used when someone wants to build from the foundation on up to a new structure. You can start from an empty lot or an old structure that will be completely torn down, old foundation dug up, and a new foundation poured, with a new structure built on top.
A renovation loan is used to add to or rebuild an existing structure on its original foundation. The renovation can be as simple as updating kitchens and baths or painting interiors and exteriors, or as complex as gutting out the entire structure and rebuilding with all new plumbing, electric, walls, floors, ceilings, and new appliances. Adding a new foundation to an existing one, in order to accommodate a large extension, falls under a renovation loan.
The next question I usually get is: What are the rate differences? Generally speaking, they are the same for both construction loans and renovation loans.
The biggest difference is the loan-to-value calculation used in determining a number of loan dollars that you can borrow for a project. That calculation is different for two main transactions, purchase or refinance.
Purchase transactions will allow up to 90% of the purchase price and the construction price. Purchase price percentage will vary when the loan amount goes above $850,000.
Refinance transactions will allow up to 80% of the After Improved Value. This is very important since, in most cases, the after-improved value will allow almost no out of pocket cost (they can be rolled into the loan) to the borrower in order to obtain and close this loan.
The Cost Based-Line Item
One very important document that is used in both options is the “Cost Based-Line Item” Excel spreadsheet that I use for the project. It allows all parties to know exactly what the total cost of the project is, at stage-by-stage values.
This form will also be used once the drawing process starts and you begin requesting monies for the line items that have been completed at that time. I work with you and the builder/contractor to make sure that all parties — you, me, and the contractors — are on the same page as to what gets paid for, and when. Doing this up front ensures a smooth build period later on with less stress for all concerned.
Of course, there are many details to be considered in all of these options, and that is where my expertise in both the construction and banking fields can help you in getting the right loan for the right job.