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Construction Loan Laws

By Genevieve Adams

Building your own home can be a rewarding process. However, to begin the process you will need to obtain a construction loan. Construction loans are not like other mortgages, as there are different requirements that need to be met. Understanding the laws and regulations that govern construction loans can give you a better concept of the construction loan process as a whole.

Home Mortgage Disclosure Act

Construction loans can be structured one of two ways, and the structure determines which federal laws apply. If a construction loan is extended to you only for the period that the actual construction is taking place, some laws will not apply. However, if your loan is for both the construction period and permanent financing afterward, more laws are applicable. The Home Mortgage Disclosure Act (HMDA) will apply only to construction-to-permanent loans. During an application for such a loan, your loan officer will ask you to provide them with your race, ethnicity and sex for government monitoring purposes under HMDA. They are required to ask you for these, and you are not required to answer if you do not wish.

Real Estate Settlement Procedures Act

The Real Estate Settlement Procedures Act (RESPA) is another law that will apply only to construction-to-permanent financing. If your loan is structured this way, the law requires the lender to give you a Good Faith Estimate (GFE) of the costs associated with the loan at the time that you apply. For a construction loan this can be especially helpful because in addition to normal things like origination fees, appraisal fees and processing fees, the GFE will also show you the costs of construction inspections and draws. This will allow you to shop the banks for the best construction costs in addition to the rest of your loan fees.

Regulation Z

Regulation Z applies to a construction loan for your home regardless of whether or not you have construction-to-permanent financing in place. Regulation Z requires that you be given a disclosure at application and at closing that shows the Annual Percentage Rate that will be charged on your loan. By comparing APRs between banks, you are actually comparing the interest rate combined with the other costs and fees associated with the loan. This allows for more accurate loan shopping. Because most construction loan funds are advanced as needed and not all at once, the APR that is disclosed to you has to be estimated because the bank does not know exactly how much will be outstanding on your loan during the construction period. Regulation Z requires that for estimation purposes, it will be assumed that half of the construction budget has been advanced for the full construction period.

Flood Disaster Protection

Any loan that will be secured by a building is covered by the flood laws. This means that when the bank makes a loan, they must determine whether your building falls within a flood hazard area and require flood insurance if it does. In the case of a construction loan, you have a chance to control the amount of flood insurance required if you are building in a flood zone. An elevation survey performed will show whether he specific area on which you are building has a high enough elevation to be above the flood area. If it is, the premiums for the flood insurance required by law may decrease.

Local Laws

When taking out a construction loan, the most important laws that you must adhere to personally are your local laws. Local laws governing construction usually cover zoning, building permits and required inspections of the finished product. Check with your county or with your city to help determine what the requirements are for your area. Inquire as to whether you are allowed to build the type of building you want on that particular land, what permits are required and how to obtain them, and when you should initiate inspections by the city personnel.

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