Residential construction loans are made on either a speculative (“spec”) basis, where homes are built to be sold later in the general market, or on a pre-sold basis for a specific buyer.
Banks engaged in residential construction lending should review the financial condition, experience, and reputation of the homebuilder/borrower and any guarantor’s to assess the likelihood that the proposed homes will be completed.
A Bank lending to residential tract builders should tailor its loan documentation to the individual project. To avoid over extending the builder’s capacity, the loan agreement should include a predetermined limit on the number of unsold units to be financed at any one time. On pre-sold homes, the Bank should review the sales contract and the buyer’s permanent financing commitment.
In larger, residential tract developments that are financed and built in sections or phases. Banks often require that some fixed percentage of units in the next section be under a firm sales contract before they will begin releasing funds for its development. Rapid sales absorption following the opening of a new section in a development does not necessarily signal strong market acceptance. Often, the first sales in a section are the most attractive lots in the section. If the Bank allows the developer to build too much inventory on the basis of these early sales, it could be left with collateral consisting mainly of less desirable, slower selling units.