Current interest rates on a residential construction loan in Salt Lake City typically range between 7.5
percent and 7.8 percent, based on credit ratings. Borrowers can expect to make a 20 percent down payment
on the loan, sometimes up to 25 percent based on the lender.
Construction lending is a pivotal driver of residential infrastructure expansion
Peri Kinder
Utah’s booming economy and dynamic landscape have long supported a robust construction industry. As the state continues to experience rapid population growth, construction lending is a pivotal driver of residential infrastructure expansion.
With the demand for residential projects rising, Salt Lake’s construction lending sector navigates regional trends to create financing options where funds are provided to individuals who want to finance the construction or renovation of a custom home-building project.
The loan can pay for acquiring property, new home construction or major renovations on an existing structure, utilities, architectural and engineering fees, materials and labor and any permits or inspection fees.
Unlike traditional mortgage loans, where a borrower has principal and interest payments on an existing home, borrowers pay interest-only on the short-term construction loan (typically 12 to18 months) and the balance rolls into a traditional mortgage loan once the project is completed.
Brian Frandsen, director of commercial lending for Granite Credit Union, said interest rates on construction loans are usually a bit higher than a mortgage loan, based on risk. Due to the inherent uncertainties and delays associated with construction projects, lenders may have strict qualification criteria and intensive monitoring processes to manage risk.
“There’s more risk because let’s say you approve someone for a half-million- dollar construction loan,” Frandsen said. “With that potential home, the more it gets built, the more it will increase in value. But in the beginning, as a lender, you’ve already committed a half-million dollars on something that’s not even worth that from Day One. That’s where the risk comes in.”
Current interest rates on a residential construction loan in Salt Lake typically range between 7.5 percent and 7.9 percent, based on credit ratings. Borrowers can expect to make a 20 percent down payment — sometimes up to 25 percent based on the lender.
Because lenders are loaning money for something that doesn’t yet exist, borrowers also need to provide (along with the minimum down payment) a detailed project description, a property value appraisal, proof they can repay the loan and they must hire a qualified builder for the project.
Once the project is approved, the loan is disbursed in stages or “draws” during construction. Draws are based on targets such as completing the foundation, framing or roofing. The lender will typically monitor the progress during construction, conducting inspections to ensure everything is going as planned and monies are being used effectively. Monitoring keeps the project on track and mitigates lender risk.
As the home project is completed, the borrower will convert the loan into a traditional mortgage loan, which will pay off the original construction loan.
With the recent rise in interest rates, some borrowers (usually first-time homebuyers who financed a construction loan) run into the problem of not being able to afford the home they just built.
“What’s happened over the last 18 months is we’ve seen interest rates dramatically increase,” he said. “A situation that some borrowers find themselves in now is that they started a construction loan 12 to 18 months ago, mortgage rates went from the high 3s, maybe high 5 for a jumbo mortgage, and now the average rate is around at 6.5 or 7 for good credit.”
Stacey Van Roosendaal, president/CEO of Sundance Lending Co., said most borrowers who take out construction loans for a custom-built home have the income and financing to absorb an increase in mortgage rates, but a younger couple who wants to custom-build their first home can run into problems. She’s seen people have to walk away from their home project.
Although she doesn’t think this as a big problem right now, Van Roosendaal said one option for borrowers is to apply for a 31-year mortgage.
“There are some great 31-year loans in the valley,” she said. “The first year is the construction loan with interest-only payments and then when the home is built, it turns into a 30-year fixed mortgage where your rates have been locked from the beginning.”
Some borrowers decide to get a construction loan for an owner-builder home, hoping to save money by doing it themselves. Frandsen said it could save money upfront but if they don’t know what they’re doing, it could go downhill fast.
“When they try to do a construction loan in their own right, they can save quite a bit of money because then they’re not paying a builder his overhead to build it,” Frandsen said. “The downside to that is unless you really know what you’re doing, it can be a very challenging thing to do. It’s very stressful because now that individual is in the driver’s seat, trying to negotiate with suppliers and subcontractors. If you’ve never done that, it can be challenging.”
Additionally, unexpected costs during construction are almost inevitable. Higher costs for supplies, contract workers and unplanned expenses can quickly add up. When this happens, homebuyers have to make some hard choices because they cannot get another loan for the project while it’s under construction.
That’s when they have to take a second look at kitchen cabinets, flooring, custom-designed areas and other ways to cut back on expenses. Maybe the basement doesn’t get finished or perhaps the quartz countertops have to be downgraded.
With cost overruns, time delays, construction quality, regulatory compliance, stress, decision fatigue and the resale value of an owner-builder home, borrowers should consider whether they have the time, expertise, bandwidth and connections to make it work.
“You have to know your mortgage payments are going to change based on all of those things,” Van Roosendall said. “Plus, there’s no way for you to know what interest rates will be in the future.”
Construction lending will continue to play a vital role in the development and growth of communities in the Salt Lake Valley. Financing for residential projects fuels economic activity, creates jobs and builds quality housing for future generations.
Even with challenges and risks, collaboration among lenders, builders and borrowers can help ensure successful outcomes. As the construction industry evolves, residential construction lending will remain an indispensable tool for realizing the dreams of homebuyers in the state.
Peri Kinder is a senior writer with The City Journals.