How to Draft a Construction Loan Agreement
A construction loan agreement is a contract between a borrower and a lender. It explains essential terms of the loan, such as the amount borrowed and the schedule for disbursing the loan. An effective loan agreement also includes promises that the borrower makes to the lender. For example, a lender will want the borrower to promise to complete the work in a timely manner, get necessary permits, and obtain certain insurance.
Beginning the Loan Agreement
Contact a lawyer with questions.You may have many questions as you draft your construction loan agreement. You should meet with a qualified lawyer to discuss these issues. The lawyer can also look over a draft of your contract when you finish.
- You can find a qualified lawyer by contacting your state or local bar association, which should run a referral program.Once you have a referral, you can schedule a consultation with the lawyer.
- Lenders, not borrowers, typically draft construction loan agreements. However, if you are a borrower, then you should show the contract to a lawyer before signing. You might be able to negotiate some changes with the lender to the contract.
Format the document.You should set up your loan agreement as a template that you can use more than once. For each loan, you can insert information specific to that borrower, such as name and loan amount.
- Set the font to a comfortable size and style. For example, Times New Roman 12 point is standard.
- Remember that you can emphasize language by making it a larger font size (such as 14 point) or by bolding it.
Title the document.Center the title “Construction Loan Agreement” at the top of the page, between the left- and right-hand margins. You should put the title in all caps, and bold it.
Identify the parties.In the opening paragraph, you should identify the date of the agreement as well as the identities of you and the borrower. Because you are creating a template, you can insert blank lines for the date as well as the name of the borrower.
- Sample language could read: “This construction loan agreement (‘Agreement’) is executed [insert blank line for date] by and between [insert blank line for name of borrower] (‘Borrower,’ ‘I,’ ‘me’ or ‘my’) and [insert your name] (‘Lender’).”
Identify the property.You should identify the property the borrower owns or will purchase. You should also explain what kind of dwelling will be built on the property.
- Write the contract in the first-person from the borrower’s point-of-view. For example, you could write, “I own or will own certain real property described in Exhibit A attached.” You then can attach a legal description of property as an exhibit.
- You can describe the building to be constructed this way: “I propose to construct on the Property certain improvements consisting of: 150,000 sq. ft., two-story office building together with all appurtenances, fixtures, and tenant improvements now or hereafter located on the Property (‘Improvements’). The Improvements shall be constructed in accordance with plans and specifications which I have delivered, or will deliver, to Lender, as amended in order to comply with the terms and conditions of this Agreement (‘Plans and Specifications’). I have requested from Lender a loan for the purpose of such construction.”
Include definitions, if required.You might want to include a section on definitions, if you think you need to define any terms.You can draft this section last. Go through your contract after you have finished a draft and find any term you think needs defining.
- You want the borrower to understand the terms. Also, if you are sued, you want the judge to be able to define the terms correctly.
State the amount of the loan.You need to identify how much the borrower is borrowing. You can also briefly describe the purpose of the loan directly after listing the amount.
- You could write: “I have signed a Promissory Note payable to Lender (‘Note’). The Note is for the loan by Lender to me in the principal amount of [insert blank line] (‘Loan’). The purpose of the Loan is to purchase the Property described in Exhibit A of this Loan Agreement and to pay for the labor and materials to construct certain improvements on the Property.”
State when the loan matures.You should also include the date that the loan becomes due. You can include a blank line to write in the date. You also might want to state any extended date.
- For example, you might write: “The Maturity Date of the Loan shall be [insert blank line], at which time all sums due and owing under this Agreement and the other Loan Documents shall be repaid in full. If I am in compliance on such date, then I may extend the maturity date to [insert an extended date]. All payments due to Lender under this Agreement, whether at the Maturity date or otherwise, shall be paid in immediately available funds.”
Listing the Borrower’s Promises
Include a promise to enter a construction contract.When you lend someone money, you take a chance that you might never get paid back. One way to increase the odds of you getting paid is to have the borrower agree to enter a construction contract with a contractor. This contract will be between the contractor and the borrower (but not you).
- Sample language could read, “I will enter into a written agreement (‘Construction Contract’) with [insert a blank line] with offices at [insert blank line for location] (‘Contractor’) for all work. The Construction Contract will state the amount I will pay Contractor for the work. It will also include blueprints and drawings, a written itemization of the work and the contract price, and an itemized description of each stage.”
Include a promise to get permits.A builder needs permits before beginning construction. As the lender, you want the borrower to promise to get the necessary permits. By getting this promise, you can protect yourself.
- You could write, “I will get all approvals of the Work (each, a ‘Permit’) that are required by any federal, state, county, or local government agency (‘Government Authorities’). I will comply with all applicable laws. Contractor will have any license required by any government authority. I will get from Contractor and give Lender copies of all license and Permits required by Government Authorities.”
Add a provision about change orders.Construction rarely goes smoothly. Instead, the contractor will need to make changes to the schedule. Changes can also cause the price to increase. You want a provision in your loan agreement where the borrower promises to get change orders in writing from the contractor.
- A sample provision might read: “Any change in the Contract Price, the Work or the Work and Payment Schedule must be in a written agreement signed by me and Contractor and approved by Lender (‘Change Order’).”
Add a right to inspect the property.You want to reserve the right to inspect the property at any time, so that you can make sure the borrower is staying on task. Be sure to include a provision like the following:
- “Lender has the right to enter the Property to inspect the Work without notice to me during normal business hours or any other times that Lender arranges. I will pay for all inspections performed at the request of Lender or of any Government Authority. Each inspection will cost [insert blank line to write in price]. Lender inspections are for Lender’s benefit only.”
Add any requirement for a survey or appraisal.You want to get the borrower to promise to have the property surveyed or appraised at your discretion. You might not want either a survey or appraisal, but it’s important to at least include the right to each in the loan agreement.
- For example, you could reserve the right to a survey by using the following language: “If Lender requests, I will provide and certify to the Lender a survey of the Property. Each survey must be satisfactory to the Lender.”
- To reserve the right to an appraisal, include this language: “If Lender requests, I will get an appraisal of the Property and the Improvements. I will get the appraisal when requested by Lender. The appraisal will show the value of the Property and the Improvements, using the tax assessment method. Lender will choose the appraiser. Each appraisal shall reflect an appraised value and be in form and substance satisfactory to Lender.”
Include a promise to complete the work.You should also include a provision where the borrower promises to complete the project in a diligent manner. Including this provision is another way you can nudge the borrower toward completing the project.
- Your sample clause could state: “I will begin Work promptly after signing the Loan Documents. I will continue to work diligently and in a good and workmanlike manner in strict compliance with the Construction Contract and all Government Regulations. The Work will not violate any of the conditions, covenants, or restrictions on the Property. I promise I will complete the Work on or before [insert blank line to write in the date] (‘Completion Date’). Lender will accept the Work as completed when I satisfy all of the conditions in this Loan Agreement.”
- Also include a statement that the borrower should contact you if a problem arises: “I will notify Lender immediately in writing in the following situations: (1) I think the Work does not comply with the Construction Contract or this Loan Agreement; (2) a notice of lien on the Property is served on me or the Contractor; or (3) any Government Authority issues any notice or claim related to the property.”
State the insurance requirements.You may want to require the borrower to purchase insurance. This insurance will help protect you in case the dwelling is damaged. You should list the insurance you want the borrower to purchase.
- Include this language: “I shall maintain at my sole expense, with licensed insurers approved by Lender, the following policies of insurance in form and substance satisfactory to Lender. I shall provide to Lender the originals of all required insurance policies, or other evidence of insurance acceptable to Lender. I shall also provide Lender with written notice at least 10 days before cancelling or materially changing any insurance policy.”
- Then list the insurance. For example, you might want the borrower to purchase the following kinds of insurance:
- Title insurance
- Property insurance
- Flood hazard insurance
- Liability insurance
Including Information on Loan Disbursal
Explain how the loan will be administered.You probably will not give the borrower all of the money at once. Instead, it is standard to disburse the money in stages, when certain benchmarks have been met. For example, you might deposit the loan amount in escrow. Then, your escrow agent will make disbursals when benchmarks have been met.
- You could write, “Lender shall disburse the Loan proceeds (‘Loan Proceeds’) on the date the Loan closes (‘Closing Date’) in escrow, to a federally insured interest bearing account (‘Escrow Account’) to be disbursed by Lender, or Lender’s escrow agent, as provided in this Loan Agreement.”
Require that conditions be met before receiving a disbursement.You need to make it clear to the borrower that you will disburse money only once conditions are met. You will disburse money in stages: for example, you will disburse money to pay for the foundation once the foundation has been poured and you can verify that it was laid.
- You should come to an agreement with the borrower about the different stages for disbursing funds and what conditions must be met. You should put this information in an appendix and mention it here in the loan agreement.
- “Lender’s obligation to make any disbursements or take any other action under the Loan Agreement shall be subject at all times to the satisfaction of each of the following conditions precedent and those certain conditions and requirements as set forth in [insert name of the Appendix].”
Insert a promise that funds will be used only for approved purposes.You want to make sure the borrower doesn’t spend money on anything unauthorized. Accordingly, insert a provision where the borrower promises to use the funds only for the approved purpose:
- “I will hold all funds in trust and apply them solely for the purposes for which the funds have been disbursed. Lender is under no obligation to monitor or determine my use or application of the disbursements.”
Request a final inspection report.You want the borrower to agree to provide you with certain documents when all work has been completed. You should list all of the documents that you want. For example, you could request the following:
- “Within six months after Work is completed, I will deliver to Lender a copy of the final inspection report, the final title endorsement, a completion certificate signed by me and Contractor, and the final, unconditional certificate of occupancy issued by the Government Authority, where required by law.”
Explaining Default and Remedies
Identify events of default.A borrower defaults when it doesn’t perform its obligations under the contract. In a section, you can identify what qualifies as default. Be sure to preface this section with the following language: “I will be in default under this Loan Agreement and the other Loan Documents if any of the following events (‘Events of Default’) occurs”:
- Nonpayment. This is typically a default: “I fail to make any payment due under any Loan Document.”
- Other broken promises. If the borrower fails to keep a promise in the loan agreement, then he or she is in default: “I fail to keep any promise in this Loan Agreement or any other Loan Document.”
- False statements made by the borrower. If the borrower misrepresents something to get a loan from you, then you will want to declare a default if you uncover the lie: “Any statement of fact, representation or warranty I make to Lender in my loan application, this Loan Agreement, or in any other Loan Document is false, inaccurate, or incomplete.”
State your rights as the lender.You should also reserve a variety of rights. You can use these if the borrower defaults on the loan. For example, you can include the following rights:
- Declare a default. If you declare a default, then you can stop making payments and even sue for breach of contract.
- Take possession of the property. After taking possession, you can then complete construction of the property.
Insert an indemnity provision.This provision protects you from lawsuits. Essentially, the borrower will promise not to sue you. Include the following indemnity provision:
- “I will indemnify and hold Lender and Lender’s affiliates, including the officers, directors, employees, and agents of Lender and its affiliates (‘Indemnified Parties’), harmless from any liability, claim, loss, cost, and legal expense incurred by or alleged against any of the Indemnified Parties arising from or related to the Property, the Work, or my default under this Loan Agreement.”
Finalizing the Construction Loan Agreement
Add a choice of law provision.If a dispute arises and you go to court, then a judge may need to interpret the agreement. You should state which state’s law the judge will apply. Generally, you use the law of the state where the property is located.
- A sample provision might read: “This Loan Agreement is entered into in the state where the Property is located (the “State”) and shall be controlled and interpreted by the laws of the United States and the State.”
Include a merger clause.You don’t want the other side to claim that there were side agreements made before he or she signed the contract. Instead, you want the contract to state that it contains the entirety of your agreement and that any prior agreements are “merged” with the contract.
- A sample merger clause might read: “This Loan Agreement and the other Loan Documents are the entire understanding between Lender and me about the Loan and may not be amended, modified, or terminated other than by a written agreement signed by me and the Lender.”
Insert signature blocks.The construction loan agreement will need to be signed by the lender and all borrowers. If there is more than one borrower, include a signature block for each. There should be a line for each person to print their name and a line for the signature. Also include lines for any witnesses.
- Before the signature block, be sure to include this language: “In witness whereof, Borrower and Lender have executed this Loan Agreement as of the date first set forth on page one.”
Include a notary block.You should sign the loan agreement in front of a notary public. Underneath the signature blocks, you can include a block for the notary.Look online to find an appropriate notary block for your state.
- This is only a basic construction loan agreement. There may be additional information to add or tweaks to be made. You should show your draft to a lawyer and ask for his or her opinion.
Video: Loan Agreement video
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