Owner-Occupied Construction Loans by Private Money Lenders

By: Dennis H. Doss & Christopher J. Donovan | Doss Law, LLP

Like consumer bridge loans, consumer ground-up construction loans fit the private money model like a glove. They are short-term, usually one year or less, the borrowers are typically creditworthy and the yields are in the double digits. Banks and other mortgage lenders have and will capture a large part of this market, but there are some borrowers who can’t be bothered to go through a bank’s red tape or who are not quite good enough for a conventional lender.  Moreover, banks apply stricter underwriting standards to construction loans because they know they are higher risk.


Before you issue a letter of intent, there are several things you should consider.

Exit Strategy. First, will this borrower and property qualify for a take-out loan at the conclusion of construction? The borrower must have the provable income and credit to qualify for a conventional loan. In addition, the borrower’s equity in the finished home must be sufficient to qualify for permanent financing. If the borrower cannot pass this test, you are in for a longer investment than you would like. If you don’t do conventional loans, refer the borrower to someone who does for a full prequalification.

Cash Reserves. The second consideration is the borrower’s cash reserves. Construction projects are notorious for going over budget. People building custom homes frequently embellish the plans as they see their “baby” coming to life.  And, a permanent lender will want to see reserves for take-out financing. Hence, if they are putting their last dime into the project at the outset, the loan should be avoided.

Budget. The third consideration, like in all construction loans, is the adequacy of the budget for the intended project. Take the plans and the budget to a professional construction estimator to determine if there is enough money in the budget to bring the home over the finish line.

Strong Contractor. Lastly, the project will only be successful if the general contractor is reliable. By that I mean, someone with a track record for getting projects built on time and on budget without legal issues, such as liens or fights with clients.

If your loan prospect has passed all of these tests, let’s talk legal.  I will only cover California and Federal laws.


NMLS (National Mortgage Licensing System)

Because the ground-up home construction loan is a consumer real estate loan, it must be made or arranged by a real estate broker or a California Finance Lender (or other exempt lenders), with an NMLS endorsement.

DRE Construction Restrictions (not applicable to CFL Lenders)

If the loan will be made by real estate broker and sold to private investors or if the broker is using private investor money to fund the loan, the broker needs to comply with Business and Professions Code 10232.3.  It requires:

  • $2,500,000 loan cap
  • 100% funding of the loan into escrow at inception
  • Undisbursed funds must be held by a “neutral, independent, escrow agent,” meaning the broker cannot hold funds
  • Disbursements must follow a draw schedule
  • Disbursements must be preceded by inspection by an independent architect, general contractor or structural engineer
  • An appraisal is completed by a qualified and licensed appraiser in accordance with the Uniform Standards of Professional Appraisal Practice (USPAP).
  • The loan documentation must describe remedies if there is a default (i.e., good construction docs–like we write).
  • Loan-to-Value Ratio, based on the finished home, cannot exceed 80%

If the broker is using its own funds to make these loans and will not be selling any portion of the loan to a private investor, these restrictions do not apply.

Dodd-Frank and Truth-in-Lending

The federal consumer protection laws are very favorable to ground-up consumer construction loans. You must still follow its disclosure scheme by providing the Loan Estimate and the Closing Disclosure following the timing associated with both. To be exempt from Sections 32 and Section 35 and Ability to Repay:

  • Must be for 1 year or less, but can be renewable beyond that
  • Ability to repay not required
  • Right to cancel does not apply, unless you are liening an existing home as well
  • No impounds required
  • 4% late charge restriction does not apply
  • HUD counselling not required
  • Points and other lender or broker fees may be financed
  • No HOEPA notice, since these loans are exempt from Sections 32 and 35
  • Mandatory arbitration clauses are still prohibited

California High Cost

California’s high cost loan scheme, embodied in Financial Code Section 4970 et seq., specifically exempts ground-up construction loans as well as loans over the Fannie Mae conforming loan limit.  Most constructions loans are well over the loan limit.

If you have the appetite for these loans, think about marketing your ability to do them to local conventional construction lenders, custom homebuilders and to real estate agents in your area. You may also want to track the sale of buildable lots in your area through the MLS and send a letter to the agents with a request to pass the information on to their clients. You can even ask your friendly title company to identify the recent purchasers of lots in your area so you can write to them directly.

© Doss Law, LLP. Attorney advertising materials. These materials have been prepared for educational purposes only and are not legal advice.  This information is not intended to create an attorney-client relationship.  Consult a knowledgeable lawyer before implementing any of the ideas in this publication.


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