Description
The doc explaining details of Modus operandi of construction finance, sources of construction finance in India, means of home construction financing.
Construction Financing in India
I. Introduction The term ‘real estate’ is defined as land, including the air above it and the ground below it, and any buildings or structures on it. It is also referred to as realty. It covers residential housing, commercial offices, trading spaces such as theatres, hotels and restaurants, retail outlets, industrial buildings such as factories and government buildings. Real estate involves the purchase, sale, and development of land, residential and non-residential buildings. The main players in the real estate market are the landlords, developers, builders, real estate agents, tenants, buyers etc. The activities of the real estate sector encompass the housing and construction sectors also.
The construction finance methodology therefore provides the framework for emerging and established Contractors and developers to tackle contracts that extend their capabilities. Approval of construction finance is related to the assessed viability of a specific project or contract, and provision of finance facilities is closely tied to certified project income. Therefore, although past financial performance of the CONTRACTOR AND DEVELOPER is taken into account, financing is not as reliant on a strong financial history (and detailed projected business performance) as is the case for other types of business financing. This means that the normal, more stringent requirements for obtaining business financing do not necessarily apply. The difficulty many sole proprietors or smaller businesses have in providing solid, multi-year financial statements is one such example. Provision of security is reduced, which removes a major constraint to obtaining finance by emerging enterprises. Furthermore, the problems posed in convincing financial institutions that a business entity is viable when it only obtains irregular contracts are overcome by focusing on a contract-by-contract viability
assessment.
II. Construction Finance- Modus Operandi STEP 1: Locate and purchase a building site. STEP 2: Purchase a house plan or have one custom-designed. STEP 3: Find a builder and obtain a contract specifying the price for construction. STEP 4: Inquire with your bank regarding a construction loan that could possibly roll over into a permanent mortgage upon completion of the house. STEP 5: Check with mortgage companies - many offer hybrid loan packages for construction of custom homes. STEP 6: Apply for the loan at your chosen lender. STEP 7: Include a financial statement (filled out on the lender's form), blueprints, a survey of the lot, a construction budget and any other information of this type that the lender requests. STEP 8: Request a construction advance schedule that matches your obligations to the builder so that you don't suffer cash-flow difficulties during construction. III. Sources of Construction Financing in India The traditional source of construction period financing is commercial banks, which have experience in assessing project construction risk. Once the project reaches the construction phase, the developer has more financing options. He can continue to develop and start construction using corporate funds, or raise the financing through non-recourse project financing The following outlines many of the most common sources for obtaining construction loans.
I.
Commercial Banks
Commercial Banks make single-family short-term and a limited number of long-term loans. They are generally the largest construction lenders on multifamily and commercial projects. They also make short-term loans to mortgage banks and to real estate investment trusts (REITs).
II.
Savings and Loan Associations: Savings and Loan associations are the largest of all lenders of both construction and permanent or long-term loans on single family housing. They also make a considerable number of construction loans for multifamily residences such as apartment houses and condominiums.
III.
Mutual Savings Banks Mutual Savings Banks are generally located within the northeastern United States. Their mortgage investments are generally concentrated in single family permanent mortgages. They tend to make only a limited number of construction loans, but do make long-term loans to mortgage bankers and to real estate investment trusts which in turn make construction loans.
IV.
Mortgage Banking Companies Mortgage Banking companies make a significant number of loans for construction and land development but are mainly intermediaries between borrowers and lenders
V.
Life Insurance Companies Life insurance companies do a minimum amount of temporary construction lending. Their principle commitments are long-term loans on commercial and multifamily projects
VI.
Real Estate Investment Trusts: These trusts provide long-term mortgages on commercial and multifamily projects and a limited amount of construction loans
VII.
Government Agencies: Approximately every sixth house built in the United States is financed by the GI loan program. The Veterans Administration (VA) makes construction loans on housing for veterans, their dependents, and other beneficiaries of deceased veterans. The Federal Housing Administration (FHA) insures mortgage loans made by approved lending institutions, however, FHA does not lend money.
VIII.
Other Sources for Loans: Finally, miscellaneous sources of loans which should not be overlooked include individuals, syndicates, service organizations, and Community Housing Authorities.
Lenders need assurance that a contractor is financially responsible, of good character and reputation, and able to carry out the work stipulated in the specifications and construction documents. A full financial statement from the contractor stating his or her assets and liabilities, investments, property owned, life insurance and other pertinent information, including a credit report is generally requested by the lender. In addition, a complete set of drawings, plans, and specifications as well as the names of all the subcontractors and their specific tasks are also generally required.
Finally, the lender appraises the site of construction and compares it with the contractor's final cost estimate. Once this is in place, the lender submits the application to the loan committe for approval.
IV. Means of Home Construction Financing A newly constructed home can be financed in three ways. 1 Builder-Financed Construction
This is the simplest approach with important advantages to the buyer, including not having to worry about the builder's financial capacity, or the complexities involved in the alternatives discussed below. 2 Separate Construction Loans and Permanent Mortgages
The obvious downside of two loans is that the buyer shops twice, for very different instruments, and incurs two sets of closing costs. Construction loans usually run for 6 months to a year and carry an adjustable interest rate that resets monthly or quarterly. The margin will be well above that on a permanent ARM. In addition to points and closing costs, lenders charge a construction fee to cover their costs in administering the loan. (Construction lenders pay out the loan in stages and must monitor the progress of construction). In shopping construction loans, one must take account of all of these dimensions of the "price". Some lenders (primarily commercial banks) will only make construction loans. Others will only make combination loans. And some will do it either way. Note: Interest on construction loans is deductible as soon as construction begins, for a period up to 24 months, provided that at the end of the period you occupy the house as your residence. The permanent loan is no different from that required by the purchaser of an existing house, or by the buyer of a new house on which the builder financed construction. Indeed, the advantage of the two-loan approach relative to the combination loan discussed below, is that the buyer retains freedom of action to shop for the best terms available on the permanent mortgage. 3 Combination Construction/Permanent Mortgages
The major talking point of the combination loan is that the buyer only has to shop once, and has to pay only one set of closing costs. The danger, however, is that the buyer will overpay for the permanent mortgage because the arrangement has limited his options. Lenders offering combination loans typically will credit some of the fees paid for the construction loan toward the permanent loan. The lender might charge 4 points for the construction loan, for example, but apply 3 of the points toward the permanent loan. If
the borrower takes the permanent loan from another lender, however, the construction lender retains the 3 points. This makes it difficult to compare combination loans with the two-loan alternative. For example, suppose the buyer wants to compare the cost of the construction loan offered by the combination lender cited above with an independent construction loan offer at the same rate plus 2 points. The buyer can get the construction loan for 1 point provided he also takes the permanent loan, or for 2 points while retaining his freedom of action to shop for the best deal on a permanent loan. Which is the better deal depends on how the combination lender prices the permanent loan relative to the competition. This is not easy to determine. While you can compare current price quotes on permanent loans by the combination lender with quotes from other lenders, these don't mean much. The actual price won't be set until after the house is built, and at that point the combination lender has an incentive to over-charge. If the combination lender insists that you will get the market price, it is time to bail out and go with two loans. V. Conclusion India still has a long way to go in building a robust institutional/regulatory framework from a risk management perspective in the construction finance sector. Construction financing lies at the intersection of three priority areas for the development of emerging economy like India — the strengthening of domestic financial systems, the financing of a one of the largest asset classes in the economy, and the provision of a critical social good. Policy makers not only in India but in other emerging economies are challenged to build sound Construction financing systems due to an increasing number of middle class people, and growing urban populations demanding home ownership. The major areas of risk experienced in the Construction financing process are legal/regulatory, market risks (demand factors and competition), credit risk (borrower and collateral), operations risk (for lending enterprises), interest rate risk, and liquidity risk. The first line of defense against loss is making good loan decisions; the second is managing the asset effectively, with risk sharing entities coming last. Credit risk insurance is only activated after the lender has done everything possible to avoid a loss on the loan.
doc_906421454.docx
The doc explaining details of Modus operandi of construction finance, sources of construction finance in India, means of home construction financing.
Construction Financing in India
I. Introduction The term ‘real estate’ is defined as land, including the air above it and the ground below it, and any buildings or structures on it. It is also referred to as realty. It covers residential housing, commercial offices, trading spaces such as theatres, hotels and restaurants, retail outlets, industrial buildings such as factories and government buildings. Real estate involves the purchase, sale, and development of land, residential and non-residential buildings. The main players in the real estate market are the landlords, developers, builders, real estate agents, tenants, buyers etc. The activities of the real estate sector encompass the housing and construction sectors also.
The construction finance methodology therefore provides the framework for emerging and established Contractors and developers to tackle contracts that extend their capabilities. Approval of construction finance is related to the assessed viability of a specific project or contract, and provision of finance facilities is closely tied to certified project income. Therefore, although past financial performance of the CONTRACTOR AND DEVELOPER is taken into account, financing is not as reliant on a strong financial history (and detailed projected business performance) as is the case for other types of business financing. This means that the normal, more stringent requirements for obtaining business financing do not necessarily apply. The difficulty many sole proprietors or smaller businesses have in providing solid, multi-year financial statements is one such example. Provision of security is reduced, which removes a major constraint to obtaining finance by emerging enterprises. Furthermore, the problems posed in convincing financial institutions that a business entity is viable when it only obtains irregular contracts are overcome by focusing on a contract-by-contract viability
assessment.
II. Construction Finance- Modus Operandi STEP 1: Locate and purchase a building site. STEP 2: Purchase a house plan or have one custom-designed. STEP 3: Find a builder and obtain a contract specifying the price for construction. STEP 4: Inquire with your bank regarding a construction loan that could possibly roll over into a permanent mortgage upon completion of the house. STEP 5: Check with mortgage companies - many offer hybrid loan packages for construction of custom homes. STEP 6: Apply for the loan at your chosen lender. STEP 7: Include a financial statement (filled out on the lender's form), blueprints, a survey of the lot, a construction budget and any other information of this type that the lender requests. STEP 8: Request a construction advance schedule that matches your obligations to the builder so that you don't suffer cash-flow difficulties during construction. III. Sources of Construction Financing in India The traditional source of construction period financing is commercial banks, which have experience in assessing project construction risk. Once the project reaches the construction phase, the developer has more financing options. He can continue to develop and start construction using corporate funds, or raise the financing through non-recourse project financing The following outlines many of the most common sources for obtaining construction loans.
I.
Commercial Banks
Commercial Banks make single-family short-term and a limited number of long-term loans. They are generally the largest construction lenders on multifamily and commercial projects. They also make short-term loans to mortgage banks and to real estate investment trusts (REITs).
II.
Savings and Loan Associations: Savings and Loan associations are the largest of all lenders of both construction and permanent or long-term loans on single family housing. They also make a considerable number of construction loans for multifamily residences such as apartment houses and condominiums.
III.
Mutual Savings Banks Mutual Savings Banks are generally located within the northeastern United States. Their mortgage investments are generally concentrated in single family permanent mortgages. They tend to make only a limited number of construction loans, but do make long-term loans to mortgage bankers and to real estate investment trusts which in turn make construction loans.
IV.
Mortgage Banking Companies Mortgage Banking companies make a significant number of loans for construction and land development but are mainly intermediaries between borrowers and lenders
V.
Life Insurance Companies Life insurance companies do a minimum amount of temporary construction lending. Their principle commitments are long-term loans on commercial and multifamily projects
VI.
Real Estate Investment Trusts: These trusts provide long-term mortgages on commercial and multifamily projects and a limited amount of construction loans
VII.
Government Agencies: Approximately every sixth house built in the United States is financed by the GI loan program. The Veterans Administration (VA) makes construction loans on housing for veterans, their dependents, and other beneficiaries of deceased veterans. The Federal Housing Administration (FHA) insures mortgage loans made by approved lending institutions, however, FHA does not lend money.
VIII.
Other Sources for Loans: Finally, miscellaneous sources of loans which should not be overlooked include individuals, syndicates, service organizations, and Community Housing Authorities.
Lenders need assurance that a contractor is financially responsible, of good character and reputation, and able to carry out the work stipulated in the specifications and construction documents. A full financial statement from the contractor stating his or her assets and liabilities, investments, property owned, life insurance and other pertinent information, including a credit report is generally requested by the lender. In addition, a complete set of drawings, plans, and specifications as well as the names of all the subcontractors and their specific tasks are also generally required.
Finally, the lender appraises the site of construction and compares it with the contractor's final cost estimate. Once this is in place, the lender submits the application to the loan committe for approval.
IV. Means of Home Construction Financing A newly constructed home can be financed in three ways. 1 Builder-Financed Construction
This is the simplest approach with important advantages to the buyer, including not having to worry about the builder's financial capacity, or the complexities involved in the alternatives discussed below. 2 Separate Construction Loans and Permanent Mortgages
The obvious downside of two loans is that the buyer shops twice, for very different instruments, and incurs two sets of closing costs. Construction loans usually run for 6 months to a year and carry an adjustable interest rate that resets monthly or quarterly. The margin will be well above that on a permanent ARM. In addition to points and closing costs, lenders charge a construction fee to cover their costs in administering the loan. (Construction lenders pay out the loan in stages and must monitor the progress of construction). In shopping construction loans, one must take account of all of these dimensions of the "price". Some lenders (primarily commercial banks) will only make construction loans. Others will only make combination loans. And some will do it either way. Note: Interest on construction loans is deductible as soon as construction begins, for a period up to 24 months, provided that at the end of the period you occupy the house as your residence. The permanent loan is no different from that required by the purchaser of an existing house, or by the buyer of a new house on which the builder financed construction. Indeed, the advantage of the two-loan approach relative to the combination loan discussed below, is that the buyer retains freedom of action to shop for the best terms available on the permanent mortgage. 3 Combination Construction/Permanent Mortgages
The major talking point of the combination loan is that the buyer only has to shop once, and has to pay only one set of closing costs. The danger, however, is that the buyer will overpay for the permanent mortgage because the arrangement has limited his options. Lenders offering combination loans typically will credit some of the fees paid for the construction loan toward the permanent loan. The lender might charge 4 points for the construction loan, for example, but apply 3 of the points toward the permanent loan. If
the borrower takes the permanent loan from another lender, however, the construction lender retains the 3 points. This makes it difficult to compare combination loans with the two-loan alternative. For example, suppose the buyer wants to compare the cost of the construction loan offered by the combination lender cited above with an independent construction loan offer at the same rate plus 2 points. The buyer can get the construction loan for 1 point provided he also takes the permanent loan, or for 2 points while retaining his freedom of action to shop for the best deal on a permanent loan. Which is the better deal depends on how the combination lender prices the permanent loan relative to the competition. This is not easy to determine. While you can compare current price quotes on permanent loans by the combination lender with quotes from other lenders, these don't mean much. The actual price won't be set until after the house is built, and at that point the combination lender has an incentive to over-charge. If the combination lender insists that you will get the market price, it is time to bail out and go with two loans. V. Conclusion India still has a long way to go in building a robust institutional/regulatory framework from a risk management perspective in the construction finance sector. Construction financing lies at the intersection of three priority areas for the development of emerging economy like India — the strengthening of domestic financial systems, the financing of a one of the largest asset classes in the economy, and the provision of a critical social good. Policy makers not only in India but in other emerging economies are challenged to build sound Construction financing systems due to an increasing number of middle class people, and growing urban populations demanding home ownership. The major areas of risk experienced in the Construction financing process are legal/regulatory, market risks (demand factors and competition), credit risk (borrower and collateral), operations risk (for lending enterprises), interest rate risk, and liquidity risk. The first line of defense against loss is making good loan decisions; the second is managing the asset effectively, with risk sharing entities coming last. Credit risk insurance is only activated after the lender has done everything possible to avoid a loss on the loan.
doc_906421454.docx