A prospective borrower called the bank--he had lost a lot of money post 9/11. Prior to his bad fortune, he had started building a new residence using his own money and acting as his own general contractor. Now, he is short of cash. He does have an income, but with his investments soured, he does not have sufficient cash to timely finish this project. He has dropped $200,000 of his own money into this new residence.

He now wants an interim construction loan with which to finish the project. He apparently has a lender willing to do the permanent (and I will get that information from him when he comes in). He said banks are telling him they will not make the loan because the construction has begun.

I know there are land mines out there in doing this. But there has got to be a practical way to get this done without putting the bank at risk. Can anyone tell me how our bank can help this desparate guy to get his house completed without getting my bank in trouble? Any advice will be appreciated.

Contact your title company who will be providing your title insurance. They should be able to assist you in obtaining the adequate title insurance to minimize your exposure in this transaction.

The easy part is getting waivers from anyone who has done work, showing that they have been paid for all the work and materials they have put into it so far. The hard part is making sure all those contractors and suppliers are identified.

Next, you'd want an iron clad take-out commitment.

The compliance issues are not that complicated, but as Lynn suggested, the biggest issue will be with making sure you can obtain clear title to the property.

Since your customer was owner/builder/financer, he probably have received all the pre-notices from the contractors/sub-contractors/suppliers, etc. that would pave the way for Mechanic's liens if he didn't pay.

Since you indicate he has been having cash flow issues, I would hazard a guess and say he may have a few Mechanic's liens already. Depending on how deep a hole he has dug, he may be in too deep for most banks to help him out and still make a "safe and sound" loan.

I hate to say this, but I can almost always spot an owner/builder/financer project. They are the ones where the framing sits, exposed to the elements, for more than 6 months. The entire house may take 2 to 3 years to complete, and many times it is completed by someone who either acquired the property in foreclosure, or bailed the owner out for pennies on the dollar.

There is no "clean" way to resolve this--at least in Texas. Every subcontractor's lien on the house from here forward will have priority over any bank lien because they relate back to the date the first work was done. If a bank takes this on, it will have to be diligent in seeing that everyone is paid. The lender should drive by every day or so and take notes on who is there working and then make sure that they are receiving payments.

What I would do is get a "bills paid affidavit" from the borrower/contractor and a "release of lien" from anyone who has already performed work. (Actually, I would have the borrower get all of these releases. Why should the banker do this work?)

Then I would wait 30 days or more to make it look like 2 distinct jobs. Then the bank could start this as a new loan. I would definitely talk to legal counsel before doing this. (I have not seen another method used, but using a home equity loan might be another unique solution--but I won't get into that here.)

Of course, before you do any of this--you should get a title company on board.

Other states may have different laws, but I do not know of any other way this has been handled in Texas.

This gets back to why banks prefer to finance construction BEFORE any actual construction is started.

NOTE - I can only speak to my experience in California:
By filing your Deed of Trust on the property, all contractors/subs/and suppliers are put on constructive notice that you have a superior lien.

You would then receive any "Pre-notices" of work to be performed or materials to be supplied. The "Pre-notices" are required before any Mechanics lien can be filed. By tracking the "Pre's" you can make sure everyone gets paid. Otherwise, you really have no idea unless you trust your borrower implicityly.
(And for anyone thinking of doing THAT, please re-visit the early 1990's!!!)