A hard money construction completion loan seems pretty easy and straightforward at 65-75% of as-is value of a partially finished home. And typically they are easy to get approved when it comes to the lender’s underwriting. Builders and house flippers, along with hard money lenders, often run into challenges from the title company’s issuance of a 2006 Alta Extended Lender’s Policy with 125% coverage.
In our experience with cash-out construction completion loans and originating purchase + rehab reimbursement loans, securing title insurance coverage can be the final hurdle that the borrower needs to overcome in order to secure financing.
Why is obtaining title coverage so difficult on construction completion or rehab loans?
There are a few factors that give the title company concern on these types of loans:
- The loans are generally short-term (12-24 months) and for a specific purpose of making improvements to the home, which will theoretically increase the value of the property with each draw or disbursement.
- Construction completion or rehab reimbursement loans often have additional disbursements post-closing. Most title policies are limited to the property as of the effective date of the policy, not something that could happen in the future like a larger loan amount or additional square footage.
- The likelihood of Mechanic’s Liens appearing on the title and taking priority over the insured deed of trust (hard money construction completion or rehab reimbursement loan).
In my conversations with title officers, they are primarily concerned with future mechanic’s liens because they could take precedent on the title over our deed of trust.
Usually, in California, liens against title take priority on a “first in time, first in right”. Yet, there can be exceptions to the rule when it comes to mechanic’s liens, which could take precedence over a mortgage if the work commenced prior to the deed of trust being recorded.
Let’s say a real estate investor (house flipper) in California bought a house on January 1st, 2015 for $500,000, taking out a $300,000 hard money loan. The intent was to add an additional 1,200 square feet, bringing the house up to 3,500 square feet and reselling for $900,000. Permitting moved incredibly slowly, taking nine months before the real estate investor could start work on the renovation on October 1st, 2015. (Work commenced and materials were delivered to the job site on October 1st).
The $300,000 loan was due on December 31st, 2015. The borrower refinanced the partially completed home on December 30th, 2015, taking out a $550,000 hard money loan that included $400,000 initial loan and $150,000 rehab reimbursement funds. Everything looked good until the title insurance company hesitated about issuing a 2006 Alta Extended Lender’s Policy with 125% coverage.
In order to prove insurability, the borrower had to provide updated financials (bank statements, investment, and retirement account statements) proving to the title company that they were financially strong enough to meet all obligations associated with the project. Usually, for a project of this size, it would take $200,000+ in liquid assets to quickly clear title underwriting.
Liquidity is important because it gives the title company enough certainty that a mechanic’s lien for an unpaid contractor or supplier bills commenced on October 1st, 2015 likely won’t be filed and take precedence over the $550,000 deed of trust recorded on December 30th, 2015. It means that the borrower/real estate investor has the means to pay their bills and most likely will carry out the project to completion.
If you’re seeking a hard money construction completion or purchase + rehab reimbursement loan, make sure that you have all your financial statements in order. And make sure that your bank accounts have at least six figures so that the title company will issue a 2006 Alta Extended Lender’s Policy with 125% coverage. This will make the process go much smoother with the lender and more importantly with the title company, who really becomes the final decision maker on if the hard money loan gets approved or is denied.