Land developers buy raw land and build water lines, sewers, roads and other utilities. The developer applies for a land development loan to finance the purchase and buildout of the subdivision.
The lender of the land development mortgage requires collateral in the form of a blanket mortgage on all the finished lots. Each lot will be assigned a partial release price that the developer will pay to the lender as the lots are sold. When payment is received by the lender, the lender releases that parcel from the mortgage and the buyer gets title free and clear of the mortgage.
Building contractors borrow funds from a lender to finance the purchase of a finished site and the materials and labor costs to construct a building. To protect the lender’s interests, the loan is disbursed as the construction is completed and inspected by the lender in draws. This is a short-term loan with interest due monthly. When the builder sells the house, the loan is repaid to the lender from the proceeds, and the lender releases the mortgage lien on the property.
When the developer of an office building or apartment complex borrows on a short-term construction loan, the lender wants assurance that the loan will be paid off when construction is complete.
The construction lender will require that the developer obtain a commitment from another lender to loan the funds to pay off the loan with permanent financing. This is called a takeout commitment.
When interest rates are high, borrowers resist making the higher payments. To help the buyers, a home builder may be willing to pay cash to the lender up front so the lender will reduce the payments in the early years of the loan.
For example, assume a buyer is interested in a home priced at $500,000 and can get a $400,000 mortgage at 6% for 30 years. The buyer is concerned about the monthly payments that are $2,398.20. In order to get the sale, the builder offers to “buy down” the first two years of the loan in a 2-1 buydown. That means the builder will pay the lender enough so the lender reduces the interest rate 2% in the first year (to 4% interest) and 1% in the second year (to 5%).
So, in the first year, the buyer’s monthly payment would be reduced to $1,910, saving $5,862 annually from the original payments. In the second year, the monthly payment would be $2,147, saving $3,010 annually. Total savings to the borrower would be $8,873. And that’s about the amount the builder would have to pay the lender for the buydown.
Here’s how it was calculated:
|Year||Interest Rate||Monthly Payment||Monthly Savings||Annual Savings|
|3 – 30||6%||$2,398.20||$0||$0|