The attorneys at Calabrese Law Associates in Boston and Burlington, Massachusetts are well versed in the laws and regulations affecting lenders. The firm also represents private lenders who are in the business of providing contractors short-term constructions loans. Federal law and Massachusetts regulations control much of the lending industry, and it’s important to understand these rules before engaging in the lending business.
Contact Our Construction Attorneys
If you have questions, our construction loan regulation attorneys in Boston, MA can assist you. Here are some things you should know about these regulations.
- Lenders
In 1993, the Federal Deposit Insurance Corporation (“FDIC”) laid out new standards to be followed by insured state nonmenber banks that offer real estate lending. 12 C.F.R. § 365. The new rules stipulated:
- Each insured state nonmember bank shall adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interests in real estate, or that are made for the purpose of financing permanent improvements to real estate.
- Real estate lending policies adopted pursuant to this section must:
- Be consistent with safe and sound banking practices;
- Be appropriate to the size of the institution and the nature and scope of its operations; and
- Be reviewed and approved by the bank’s board of directors at least annually.
- The lending policies must establish:
- Loan portfolio diversification standards;
- Prudent underwriting standards, including loan-to-value limits, that are clear and measurable;
- Loan administration procedures for the bank’s real estate portfolio; and
- Documentation, approval, and reporting requirements to monitor compliance with the bank’s real estate lending policies.
- Each insured state nonmember bank must monitor conditions in the real estate market in its lending area to ensure that its real estate lending policies continue to be appropriate for current market conditions.
- The real estate lending policies adopted pursuant to this section should reflect consideration of the Interagency Guidelines for Real Estate Lending Policies established by the federal bank and thrift supervisory agencies.
12 C.F.R. § 365.2.
Appendix A to Subpart A of Part 365 (12 C.F.R. §§ 365.1-365.2) created guidelines for the creation of the required policies. The guidelines were designed to assist lenders with the creation of appropriate policies, which the FDIC recommended “contain a general outline of the scope and distribution of the institution’s credit facilities and the manner in which real estate loans are made, serviced, and collected.”
Policies concerning real estate loans must consider a wide range of factors, which include but are not limited to:
- Geographic area in which lending will be considered;
- Portfolio diversification;
- Procedures for originating and approving loans, including:
- Underwriting standards, which should “reflect all relevant credit factors, including” but not limited to:
- Borrower’s capacity to service the debt;
- Property Value;
- Existence of secondary repayment sources;
- Maximum loan size, depending on the type of property
- Loan-to-Value Limits
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- FDIC recommended establishing internal limits depending on the type of property, with certain supervisory limits generally not to be exceeded:
Loan Category Loan-to-Value Limit (Percent) Raw Land 65 Land Development 75 Construction: Commercial, multifamily,*1 and other non-residential 80 1 to 4 Family Residential 85 Improved Property 85 Owner Occupied 1 to 4 Family and Home Equity *2 *1 Multifamily construction includes condominiums and cooperatives.
*2 A loan-to-value limit has not been established for permanent mortgage or home equity loans on owner-occupied, 1- to 4-family residential property. However, for any such loan with a loan-to-value ratio that equals or exceeds 90 percent at origination, an institution should require appropriate credit enhancement in the form of either mortgage insurance or readily marketable collateral.-
- Limits should be applied to the property that collateralizes the loan.
- For loans that fund a multi-phase project, the applicable limit should be for the final phase
- Establishing the limits should also include considerations of local market conditions
- Other credit factors may make it appropriate to allow a loan with a loan-to-value ratio in excess of the supervisory limits, but:
- The aggregate of the excess should not exceed 100% of total capital
- Total loans for commercial, agricultural, multifamily or non-1-4 family residential properties should not exceed 30% of total capital
- The Appendix also provides a list of transactions that serve as examples of this situation.
- Minimum requirements for granting a loan
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- Administration
- Documentation
- Type and frequency of financial statements
- Closing and Disbursement
- Collections and foreclosure, including the timing thereof
- Followup and delinquency
- Claims processing (defined as “seeking recovery on a defaulted loan covered by a government guaranty or insurance program”).
- Servicing and participation agreements
- Standards for allowing exceptions to the general lending policy
- Supervisory Review
- Underwriting standards, which should “reflect all relevant credit factors, including” but not limited to:
- The institution’s size and financial condition;
- The size and expertise of the staff;
- Market Conditions;
- Local elements, such as demographics, zoning requirements, and economic indicators; and
- Compliance with all laws and regulations related to real estate.
12 C.F.R. § 365, Subpart A, Appx. A.
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- Purchase Money Mortgage for Residential Property
A purchase money mortgage happens when the buyer of real property gives the seller a mortgage on the property for an unpaid balance of the purchase price. This often happens if the buyer is unable to qualify for a loan that covers the full purchase price. Federal law does not appear to have any regulations specific this type of lending policy, but all other loan and mortgage regulations still apply.
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- Commercial Loans
Commercial loans are used to purchase properties that are not occupied by the owner(s) of said property. A property is deemed not to be owner-occupied if at least 50% of the primary source of repayment for the loan “is derived from third-party, unaffiliated income”. According to the Office of the Comptroller of the Currency’s (OCC) Handbook on Safety and Soundness in Commercial Real Estate Lending (Version 1.1), loans of this nature are risky for a variety of reasons, such as:
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- Borrower’s ability to repay the loan (i.e. credit)
- Construction Issues;
- Market conditions;
- Regulatory changes;
- Interest rates; and
- Liability related to environmental issues.
- Liquidity
- Operational Risk
- Compliance with building codes
- Ability to provide proper oversight
- Borrower’s ability to repay the loan (i.e. credit)
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In an effort to limit the risk, the FDIC recommends a supervisory loan-to-value limit of 80% of the property’s value.
Lending standards vary, depending on the kind of institution making the loan. For national banks, the standard is set forth in 12 C.F.R. 34.62:
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- Each national bank shall adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interests in real estate, or that are made for the purpose of financing permanent improvements to real estate.
- Real estate lending policies adopted pursuant to this section must:
- Be consistent with safe and sound banking practices;
- Be appropriate to the size of the institution and the nature and scope of its operations; and
- Be reviewed and approved by the bank’s board of directors at least annually.
- The lending policies must establish:
- Loan portfolio diversification standards;
- Prudent underwriting standards, including loan-to-value limits, that are clear and measurable;
- Loan administration procedures for the bank’s real estate portfolio; and
- Documentation, approval, and reporting requirements to monitor compliance with the bank’s real estate lending policies.
- Each national bank must monitor conditions in the real estate market in its lending area to ensure that its real estate lending policies continue to be appropriate for current market conditions.
- The real estate lending policies adopted pursuant to this section should reflect consideration of the Interagency Guidelines for Real Estate Lending Policies established by the Federal bank and thrift supervisory agencies.
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Federal savings associations and service corporations are required to establish and maintain loan documentation practices that:
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- Ensure that the institution can make an informed lending decision and can assess risk on an ongoing basis;
- Identify the purpose and all sources of repayment for each loan, and assess the ability of the borrower(s) and any guarantor(s) to repay the indebtedness in a timely manner;
- Ensure that any claims against a borrower, guarantor, security holders, and collateral are legally enforceable;
- Demonstrate appropriate administration and monitoring of its loans; and
- Take into account the size and complexity of its loans.
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12 C.F.R. 160.170.
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- Construction Loans
Construction loans concern the development of real property and are defined as “extension[s] of credit for the purpose of erecting or rehabilitating buildings or other structures, including any infrastructure necessary for development.” 12 C.F.R. 160.101, Appx. For construction loans, the FDIC requires an institution’s real estate lending policy to “establish, commensurate with the size and type of the project or property”:
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- Requirements for feasibility studies and sensitivity and risk analyses (e.g., sensitivity of income projections to changes in economic variables such as interest rates, vacancy rates, or operating expenses).
- Minimum requirements for initial investment and maintenance of hard equity by the borrower (e.g., cash or unencumbered investment in the underlying property).
- Minimum standards for net worth, cash flow, and debt service coverage of the borrower or underlying property.
- Standards for the acceptability of and limits on non-amortizing loans.
- Standards for the acceptability of and limits on the use of interest reserves.
- Pre-leasing and pre-sale requirements for income-producing property.
- Pre-sale and minimum unit release requirements for non-income-producing property loans.
- Limits on partial recourse or nonrecourse loans and requirements for guarantor support.
- Requirements for takeout commitments.
- Minimum covenants for loan agreements.
12 C.F.R. § 365, Subpart A, Appx. A.
How to Contact the Experienced Real Estate and Construction Loan Attorneys at Calabrese Law Associates in Boston and Burlington, Massachusetts
If you have a question about a real estate or construction project loan in Massachusetts or if you are interested the regulations that govern construction loan lenders in Massachusetts, we encourage you to contact our office in Boston or Burlington, Massachusetts right away before such a loan is finalized. Our construction loan regulation lawyers can advise you.
To contact our office, simply call us at 617-340-6623 or fill out our client intake form, and one of the firm’s construction lawyers will get in touch with you within one business day.