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Real Estate

2006-03-01 10:52:00

Should I secure my own loan?

ANSWER:  You decide. This horror story comes right out of the Midwest!  Jim (not his real name) was going to build a house. Jim contacted a builder who seemed to have a pretty good reputation. To save some money, Jim was going to secure his own construction loan. The builder would then draw down on the construction loan as the house was being completed. Everything went fine until Jim started noticing that the builder was never on the job site and that subcontractors would come in some days, and on other days there was no sign of them. Delay after delay occurred, and then one day Jim was served notice that the builder had filed for bankruptcy. A visit to the bank showed that the builder had drawn the construction loan down more than the stage of construction would warrant. This home was valued at $400 thousand. Here's exactly what happened. The builder was a very good friend of the appraiser, responsible for inspecting the construction and reporting back to the bank. In this way, the appraiser was responsible for the amount of money the builder could draw. Since the builder was his friend, the appraiser took his word for the percentage completed, rather than inspecting the job himself. As it turns out the builder actually pulled down 35 percent more than he had completed. Now think about this. We have a $400 thousand house with a $300 thousand construction loan. The builder had completed only 25 percent of the job but had received 60 percent of the money and not paid many of the sub-contractors that had worked on the house.. To complete the house, Jim would need to take $200,000 out of his own pocket, and pay attention to this. The builder is in bankruptcy so Jim's house is tied up in litigation. It may take months to untangle this mess.How could Jim have avoided this situation? First, never give the builder the ability to draw on your construction loan.  The builder should provide a draw request to you, which allows you to inspect progress and control the flow of funds to the builder.  Also check the sub-contractors and make sure they are getting paid. If for some reason they are not, this is a red flag.  Even though you have a builder to organize and schedule the building process, you must treat this as your project. The construction lender will also send out an inspector to make sure the home is progressing to meet the draw requests for degree of completion.  Make sure the percentage of draw equals the average rate of construction. It is important to check out the builder very carefully. Get references and call each one. Ask for buyers who used the builder two years ago and one year ago, etc. Also get a reference from someone who is currently using the builder. Ask these questions: Was your building job completed on time? Were there any surprises? Did the builder respond to your problems in a timely manner? Did the builder handle any warranty work in a timely and professional manner? The main point here, and I can't stress this enough, is if you don't have the time or desire to supervise the project don't get your own construction loan.  Many builders can and will get their own construction loan if they need to, which removes some the responsibility from you as a new home buyer.