Loan Documentation Process
Loan Documentation Process Checklist for Both construction and permanent lenders. They require much of the same documentation at the time they make their commitments.
Pre-commitment Documentation in Loan Documentation Process
Both construction and permanent lenders require much of the same documentation at the time they make their commitments:
- Executive Summary of loan request.
- application; completed and signed.
- feasibility study and market analysis.
- final plans and specifications approved by lender’s architect or engineer (if new construction).
- detailed cost breakdown.
- survey and soil tests.
- appraisal.
- current financial statements.
- credit reports.
- the partnership agreement or corporate resolution.
- permanent loan commitment (construction loan only).
Borrower’s Pre-closing Documentation in Loan Documentation Process
Before the loan can be closed:
- title insurance commitment.
- hazard and liability insurance.
- evidence of the availability of utilities.
- evidence of compliance with zoning.
- building permit (if new construction).
- copies of contracts with general contractors and subcontractors (if new construction).
- labor and material payment bonds (if new construction).
- standard lease form.
- lien waivers (before final disbursement).
- certificate of occupancy permanent loan only).
Title Insurance Commitment
The lender may reserve the right to approve the title company that is to perform the search and issue the title insurance. Title insurance assures the lender that no liens have been filed prior to its own. The title report should include all easements and other restrictions on the property. The title binder should name the lender as the insured. The policy is usually issued after the loan is closed.
Hazard and Liability Insurance
Insurance coverage is necessary even before the construction of a project begins. The builder should be required to carry all-risk hazard coverage as well as liability, to protect the owner and contractor in the event of an accident at the construction site. On an existing building or as a new building nears completion, the permanent lender will insist that the policy be endorsed for occupancy by tenants and that the amount of coverage is equal to the value of the completed building.
Evidence of Availability of Utilities
To show that gas, electric, water, sewer, and telephone service will all be available upon completion of the project, the borrower furnishes the lender with copies of letters containing a statement to this effect from each utility company or municipal authority involved.
Evidence of Compliance with Zoning
Zoning compliance may be confirmed by an attorney’s opinion or a letter from the appropriate jurisdiction stating how the property is zoned and that the use or proposed use complies with zoning regulations.
Building Permit (If New Construction)
The loan should not be closed nor any funds advanced until the contractor can show that a building permit has been issued by local authorities.
Copies of Contracts (If New Construction)
Obtaining copies of contracts with the general contractor and subcontractors aids the lender in a number of ways. First, the lender is assured that the contracts do exist, which should help keep construction on schedule. Second, the amounts of the contracts can be checked against the cost breakdown furnished to see that the figures coincide. The lender can also take this opportunity to obtain references on the contractors to assure their reliability.
Labor and Materials Payment Bond (If New Construction)
Cc is often required to obtain a bond to protect the lender if the contractor defaults before the project are completed. Under the terms of this bond, the bonding company would pay the builder’s debts for labor and materials furnished so that none of the suppliers or laborers could attach a lien to the property.
Standard Lease Form in Loan Documentation Process
Since the lender could become the owner of the property through foreclosure, the lender will review the tenant as thoroughly as if it was the lessor.
Lien Waivers
A lien waiver is a form signed by each subcontractor stating that the firm has been paid for its work and waiving its right to file a lien against the property.
Certificate of Occupancy (Permanent Loan Only)
This document is issued by a local government authority on completion of construction and permits the building to be inhabited.
Lender’s Pre-closing Documentation
The lender prepares a number of documents in preparation for the closing:
- construction loan agreement (construction loan closing only).
- mortgage or deed of trust/security agreement.
- promissory note.
- assignment of contracts (construction loan only).
- assignment of leases and/or rents.
- assignment of permanent lender’s commitment (loan closing only).
- buy-sell or tri-party agreement (when both construction and permanent loans are made).
- pre-construction affidavit (if new construction); completion guaranty (if new construction).
Agreement in Loan Documentation Process
The loan agreement sets forth the right and obligations of the lender and the borrower. It includes a number of components:
1. Identification of the parties involved.
2. Property; it will be secured by (mortgage or deed of trust).
3. Description of construction to take place–plans and specifications, contracts, and cost information are made a part of the agreement.
4. Disbursement procedures–how the amounts advanced completed construction are determined; at what intervals payments will be made and to whom; forms required for payment
5. Holdback provision permitting the lender to hold back or retain 10-20 percent of the loan amount until all subcontractors ha been paid and the required occupancy level is met.
6. Borrower’s covenants wherein borrower agrees to:
- 1- Use the funds only for construction of the described project.
- 2- Construct according to plans and specifications, within budget and according to schedule.
- 3- Obtain all government approvals (zoning, health and building).
- 4- Protect the lender’s lien position.
- 1- Inspect work at the site.
- 2- Release funds only as substantiated by the inspector’s report.
- 3- Require borrower to deposit equity funds.
- 4- Approve in advance any changes in plans and specifications.
7. Lender’s covenants wherein lender reserves the right to:
8. List of documents the borrower is required to furnish prior to closing.
9. Stipulation that required fees be paid by borrower before or at closing.
10. Default and remedies provisions.
Mortgage or Deed of Trust and Security Agreement
These are the instruments used to give an interest in the property to the lender as security for the payment of a debt. Whether a mortgage or deed of trust is used varies with state law. The security agreement is often incorporated in the same form. Some of the significant clauses in a mortgage are:
- acceleration
- default
- prepayment
- remedies
- subordination
The acceleration clause permits the lender to demand payment of the entire balance of the mortgage if the borrower defaults on any provision.
The default clause defines conditions that the borrower must meet or risk legal action and foreclosure by the lender. In addition to making payments on time, the borrower is required to pay the taxes and insurance, keep the property in good condition and notify the lender before selling the property. Provisions for notifying subordinate lenders may be included as well.
The prepayment clause states whether or not a borrower may repay the loan before it is due, and if so, the amount of the payment permitted and the penalty imposed by the lender if any. This is the lender’s protection against losing a profitable investment when interest rates decline. The remedies provision permits the lender to cure the borrower’s default if it wishes. In construction loans, this clause permits the construction lender to complete the project and turn it over to the permanent lender.
The subordination clause makes other debts or rights in the real estate second to the mortgage. Construction lenders usually demand that the mortgage on the land be subordinated to the construction mortgage. Leases may also be subordinated; ground leases are often subordinate to leasehold financing.
Promissory Note in Loan Documentation Process
The promissory note is a written promise to pay a sum of money at a stated interest rate during a specified term. This document makes the borrower liable for the debt and is secured by the mortgage.
Assignment of Contracts
This document assigns the borrower’s contracts with the general contractor and subcontractors to the lender. In the event the borrower defaults before construction are complete, the lender would be able to require the contractors to finish the project.
Assignment of Leases and/or Rents
This document assigns the borrower/lessor’s interest in leases and rents to the lender. This ensures that in the event of default, the lender will be able to enforce current leases and collect rents. In the case of a construction loan in default, the construction lender has the opportunity to lease the remaining property in order to meet the permanent lender’s requirements.
Assignment of Permanent Lender’s Commitment
Assignment of the permanent commitment to the construction lender serves two purposes–it prevents the borrower from renegotiating the commitment without the construction lender’s knowledge and approval, and it gives the construction lender the right to cure the default by the borrower so that the commitment will be funded and the construction loan repaid.
Buy-sell or Tri-party Agreement
A buy-sell or tri-party agreement is a written agreement between the borrower, construction lender, and permanent lender. it is executed prior to the closing of the construction loan and has the sale and assignment of the mortgage to the permanent lender on the completion of construction as its final aim.
The obligations of each of the parties are set forth. The borrower agrees to abide by all terms in the agreement.
The construction lender agrees to:
- make the construction loan, provided it will be repaid by the permanent.
- loan; prohibit assignment of the mortgage, except to the permanent lender.
- prohibit prepayment of the loan.
- inspect the project periodically to ensure compliance with approved plans.
- The permanent lender agrees to.
- The permanent lender approves in advance any pertinent documentation drafted before the construction loan closing, but as a part of the buy-sell agreement reserves the right to.
- approve or refuse to allow future changes in the plans and specifications.
- approve leases drawn up after the construction loan closing.
- inspect the construction site to ensure compliance with approved plans.
- approve final title examination and policy.
One of the purposes of any permanent loan commitment is to assure the construction lender that the short-term loan will be repaid. A buy-sell agreement offers more protection against the delay by spelling out what, specifically, is required as evidence of completion by the permanent lender. It also uses a single set of papers to avoid disputes between the borrower and permanent lender at the time of the permanent loan closing.
Permanent lenders also benefit by using buy-sell agreements. In addition to giving them the right to approve documentation and changes in plans and to make inspections during construction, the buy/sell agreement ensures that the borrower cannot seek other permanent financings if rates should fall.
Pre-construction Affidavit in Loan Documentation Process
This document is a sworn statement signed by both the property owner and contractor stating that:
- there are no outstanding judgments against the owner or the owner’s firm.
- there are no lawsuits pending against either party.
- the owner has not authorized anyone to execute a lien against the property.
- a true itemization of construction costs has been furnished.
- no materials have been delivered to the site.
- no work has yet been performed on the project.
The pre-construction affidavit protects the lender from prior liens (although the title company also insures against this) and mechanics liens. Mechanics liens are claims against the property by people who furnished material or labor for the project. In some states, mechanics liens have priority over a lender’s lien.
Completion Guaranty
Some construction lenders require a party other than the borrower to guarantee the completion of construction of the property and repayment of the debt. The completion guaranty gives the lender the right to take action against the guarantor without first having to use all its options against the borrower.
