A structural home renovation loan with a cost plus contract isn’t accepted by most lenders.
Find out why that is so, and how we were able to help this couple get approved.
Summary: Structural Home Renovation Loan
| Details | Description |
|---|---|
| Purpose | The couple wanted a structural home renovation loan with a cost plus contract. |
| Loan Amount | $950,000 ($550,000 existing mortgage plus a $400,000 renovation loan) |
| Security | $1,450,000 (Valuation once renovation is complete) |
| LVR | 65.52% |
| Problem | Cost plus construction loans are not accepted by most lenders. Even among the ones who do, lending criteria are strict. |
| Solution | We were able to get the couple approved with a major lender by getting an exception to standard lending policy based on the strength of the application. We were also able to get them a better interest rate. |
| Takeaways | Mortgage brokers at Home Loan Experts can use their credit expertise and relationships with lenders to get you over the line in complex scenarios. |
The story
A customer called us after they were declined by their own bank.
They were looking to do an extensive renovation on their property and had applied for a structural home renovation loan.
They ticked all the boxes and even got pre-approved with their existing lender. As it stood:
- They had a council approved building plans including dimensioned floor plan and elevations.
- They had more than enough equity in the property to do the renovations.
- They had a Quantity Surveyor Report detailing anticipated construction costs of the building/construction works.
- They also had drawn up a standard ACT Master Builders Association document with the ACT recommended clauses included to convert to a cost-plus contract.
So, what was the problem?
Just when they had planned to start building, their bank came back and reviewed the building plans and specification and categorized her proposal as an owner-builder and declined the loan – they were flabbergasted.
The customers didn’t even have an owner-builder license, to begin with!
Finally, they started looking for other options and after some research online, they found us. They filled in our online assessment form, and one of our specialist mortgage brokers, Manish Rana made the call.
Over the course of the conversation, Manish established the customers’ requirements and objectives; they required at a bare minimum a:
- Speedy approval so they can start to build.
- Construction loan under a cost-plus contract.
- Competitive interest rate.
Why are cost-plus construction loans difficult?
The crux of the issue is that cost plus construction loans do not have a fixed price and this is a problem for the bank! They cannot be sure that you have the funds to complete the project. The last thing that the bank wants is to be left with a half-finished house as security for a large home loan.
“Building contracts where the price is not fixed represent an increased risk to both the customer and the Bank as the cost may increase significantly and this could result in the customer having no access to further equity or borrowings to complete the construction. The customer should have access to substantial additional equity, borrowings or surplus funds to cover increased costs, should they arise.”
However, there are lenders that can do cost plus construction loans, albeit with stricter lending criteria.
Lenders have this policy where, “construction must be completed under a fixed price building contract unless the value of the building contract is equal to or greater than $1 million, in which case Cost Plus contract may be considered.”
Moreover, for these types of contracts, generally, lenders require a minimum of 10% as contingency funds.
The solution
Our broker identified all the lenders that can do cost plus construction loans, then he narrowed the list further down to only those with competitive rates, and finally to ones with lenders well equipped to handle these types of loans.
The last part is rather important here because even though many lenders technically do construction loans, their system and staff are not well equipped to handle construction loans, especially ones with cost-plus contracts.
One other advantage of applying via a mortgage broker is that we have the ability to run the deal (scenarios) directly past the lenders before actually submitting the deal. So, we have a fairly clear idea of the deal being acceptable to that lender before officially needing to submit an application.
Having built up direct relationships with lenders over the years, our broker, Manish was able to run the scenario directly past a few lenders – this is really key in getting complex loans over the fence.
In this case, since the total loan amount was less than $1 million, it didn’t fall under their standard lending policy for these types of loans.
We raised an exception to policy by applying with a higher credit authority at the lender. This was helped by the fact that the clients had an additional $80,000 funds to cover a 20% contingency, which helped strengthen the deal and mitigate some of the risk for the lender.
We ran the scenario past two lenders. Having two lender options meant we always had a backup plan.
And once we got the green light from those two lenders who could approve the deal as is, we made our recommendation.
Our recommendation
The detailed recommendation included lender names, home loan product information such as interest rates, comparison rates, loan to value ratio, loan amounts etc.
Since, at the time of submission, one of them had a faster turnaround time than the other. The customer accepted our first recommendation.
We submitted the deal as a cost-plus construction loan and got them approved.
In the end, they got a great refinance plus structural renovation loan with a great interest rate. The new interest rate was 0.52% (52 basis points) lower than the customer’s existing rate.
Moreover, the loan was structured (split into a variable and fixed portion) in such a way as to allow the customers to focus on repaying the $400,000 faster with the help of an unlimited offset account.
Golden tips
- For cost plus construction loan contracts, you’ll need up to 10% set aside funds to the bank for additional costs. So the bank will retain the 10% of the total construction fund as a safe fund to cover any variation during the build process which will be reimbursed once the construction is completed.
- Talk to a mortgage broker before applying for a loan with your own bank. Construction loans including renovations are complex and many banks are simply not well equipped to handle these types of loans. Besides, just because you have a loan with a particular lender doesn’t necessarily mean you’re getting the best deal.
Do you need a structural home renovation loan?
Our mortgage brokers specialise in construction and renovation loans.
Talk to one of our specialist mortgage brokers by giving us a call on 1300 889 743 or by filling in our online assessment form.
