Information Lenders Need
We know you're eager to get started, but first you'll need a hard-nosed look at finances. Your budget will affect every aspect of your home, from its size to its level of amenities to its location. Now's the time to meet with a lender or loan officer to find out what you can afford or how to start adding to your log home nest egg. With a dollar figure in mind, you can begin designing and planning for your home.
Because building a home from scratch is quite different from buying an existing home, you should talk to a lender who has some experience with construction lending. The lender will review your financing options and steer you clear of common pitfalls.
Log homes now account for more than 6 percent of all custom-built, single-family homes built in the United States. However, financing any custom-built home, whether owner-built or contractor-built on owner's land, presents some unique financing problems. This section reviews the various means of financing a custom-built home and what you can do to make it easier for a financial institution to lend you the money you need to build your home.
You'll Need Two Loans
Whether you intend to build your new home yourself or have a professional build it for you, chances are you'll need two loans before your new log home becomes a reality. The first is a construction loan that provides money to pay the bills during the building of the home. The second is the standard 15- to 30-year mortgage loan.
The two loans are necessary because financing any home — frame, brick or log — that you will build yourself or have built for you on your land has different collateral requirements than financing an existing home. When financing an existing home, a banker determines the value of the home through an appraisal and then agrees to lend a percentage of the value to you as a mortgage. The home actually serves as collateral for the mortgage. This collateral is what the bank needs to secure its loan in the event you do not meet the terms of the mortgage.
Financing a home that you want to build or have built on your land is more complex because there's no existing home to serve as collateral, only the potential that a home will exist when construction is complete. In this situation, loan officers require other assets for collateral. They also will want more information about your personal finances and your ability to build the home if you are doing some or all of the work or contracting the work yourself. The other assets can be personal property, such as stocks and bonds, land, cash in savings accounts, or, as we'll see, an agreement by a bank to grant a long-term mortgage loan when the home is completed.
The Mortgage Loan
The 15- to 30-year home mortgage loan is a familiar part of the lives of most families, but qualifying for one can seem mysterious if you haven't been there before. Knowing what financial and personal information is needed and how to pre-qualify yourself before applying for the loan will help take some of the mystery out of the process.
Lending institutions will usually insist that you invest at least some of your own money in the home in the form of a down payment before they will grant a long-term mortgage. The more you invest, the better they like it because it reduces their risk. Lending institutions prefer loans with 20 percent down payment from the owner, and they offer better terms to induce you to do so. However, lenders will make mortgage loans when the borrower has only a small percentage down payment or investment in the home, but these loans require mortgage insurance to reduce the bank's risk.
Other factors that lenders consider before making a mortgage loan are the ratio between your income and the expected mortgage payment and the ratio between your income and your total long-term debt. These ratios vary slightly from individual to individual, but as a general rule, the lending institutions require that the expected monthly mortgage payment cannot be more than 28 percent of your monthly gross family income. This percentage may vary depending on the size of your down payment and your financial situation.
The second ratio lenders consider is the ratio between your installment debt payments per month, including the mortgage payment, and your monthly gross family income. In general, this ratio should not exceed 36 percent.
Using these ratios, if your monthly gross family income is $3,000, the maximum mortgage payment the bank will allow would be $840. If you have a car payment of $165, you can still qualify because your installment debt limit is 36 percent of $3,000 or $1,080. Your mortgage payment, plus the car payment, total only $1,005.
There are many other factors that lending institutions consider before making a mortgage loan, so only use the above information as a guide to determine your borrowing ability. Once you have qualified for a mortgage loan, the bank will issue a take-out letter indicating that the construction loan can be paid off with the proceeds of the mortgage loan. With this letter in hand, you are now ready to apply for a construction loan.
The Construction Loan
A construction loan is a short-term loan that is separate and distinct from the long-term mortgage loan. Its purpose is to pay for the materials and labor needed to build your home. These loans are made for periods of six to 18 months and have interest rates a few points over the current prime rate because they are considered riskier than normal, secured loans. They are usually made to professional builders, but are also available to do-it-yourself builders. Still, many lending officers remain wary of making construction loans to individuals.
Before granting construction loans, bankers carefully study the project and evaluate the ability of the builder or owner-builder to complete the home according to the plans, budget and schedule. This extra caution is understandable when you realize that you are asking a banker to lend you, an inexperienced builder, money in the expectation that you will build a home that eventually will serve as collateral.
The take-out letter mentioned earlier assures the bank making the construction loan that you have qualified for a mortgage and that the loan will be repaid from the proceeds of the mortgage loan once the construction work is done. This process can be simplified considerably if both the construction loan and the mortgage loan are obtained at the same bank. Fees and paperwork can be reduced, and it will save time.
Money from your construction loan is not simply credited to your account, as is the case with other loans. Construction loan funds are released in the form of construction draws keyed to the amount of construction work actually completed. In most cases, the money is paid out by the bank in exchange for proof that labor and materials were used to build the home. Progress is verified by on-site inspections conducted at pre-determined intervals during the construction process by an agent of the bank
Each financial institution will have its own rules, but generally, some percentage of the loan will be released as specific points in the building process are reached. For example, once your foundation has been finished and inspected by the bank's agent, the bank will release roughly 25 percent of the loan into your account. This amount should be enough for you to pay for the work up to that point and get started on the next step.
Typically, there can be four to six construction draws during the complete building cycle:
First Draw on completion of the home's foundation.
Second Draw on completion of a weathertight house shell.
Third Draw on installation of electrical, plumbing and HVAC systems.
Fourth Draw on completion of interior finish and trim and installation of appliances and bathroom fixtures.
Fifth Draw on completion of house, building and loan inspections.
Sixth Draw 60 to 90 days after completion or after sufficient time for the filing of mechanics' liens.
Your advantage in this process is that you don't pay interest until the money is dispersed by the bank, then you only pay interest on the amount drawn. If the construction loan is $100,000, for one year at 10 percent, the interest won't end up being $10,000, as might appear to be the case. The interest should only be a small fraction of that amount, since the full $100,000 will not be drawn until the last of the work has been done, usually close to the end of the term.
The construction of a log home presents a slightly different situation to the bank providing the construction financing because you will be purchasing a large percentage of your material, often $25,000 or more, in one package from the log home producer.
Log home producers often require a substantial portion of the cost of the package in advance of cutting and delivery. You should avoid making a large down payment on the logs until you have secured financing for the entire home but, once you have your financing, there are several ways to proceed.
Some lenders view a log package as just another load of lumber, or as work under way at the producer's plant, and release funds to pay for it when you and the manufacturer request.
In other cases, the bank may refuse to release any money until the package is actually present on your lot. In these circumstances, the bank should issue a promissory note — sometimes called a letter of credit, an assignment form or a voucher check — to the log home producer guaranteeing that payment will be made on delivery. Often the bank can wire transfer the money directly into the log home producer's account the same day that the logs are delivered.
Your builder-dealer should be able to help you arrange with the bank and the log home producer for the most convenient financing of the log package.Don't underestimate the value of providing potential lenders with detailed information about yourself and your home-building project when you first approach them for a loan. The bank will want to know exactly what you're going to build, how much it will cost, how long it will take, who will do various portions of the work and something about your ability to get the job done, on time and within budget. That information will allow the bank to appraise the value of your home and determine how much they will lend you to build it.
In general, the construction loan and the home mortgage will require the same information, so you can prepare one package that will satisfy both lenders if you are getting separate loans. The mortgage lender is more concerned with your employment history, income and financial situation, while the construction lender is more interested in your building plans. Both, however, require the same information to some degree.
Questions Lenders Ask
Lenders want to know if the money loaned will be returned in full with interest and with as little risk to them as possible. To assure themselves that it will be, some or all of the following information must be provided sometime during the loan-processing procedure:
Monthly Family Income. If your spouse will quit work after you move into your new log home, you may not include this income into the total.
Other Income Sources. Include bonuses, dividends, part-time employment or anything that can be considered an income source as reported to the Internal Revenue Service.
Credit History. Most lenders will insist on a credit report, which usually costs $25 to $100 payable at the first meeting. This money is not refundable even if the loan is rejected.
If you are not sure about your credit rating, you can request a credit report on yourself from the local credit bureau. You will be charged the same fee for the report, which under the law has to be submitted to you. If the information on the report is in error or the report needs to be updated, you can work with the credit bureau to make the report current before you apply for a loan.
The three major credit reporting agencies are:
• Experian 888-397-3742
• Trans Union 800-888-4213
Tax Returns. Whether you are self-employed or not, the lender will usually want a copy of your federal tax returns for the past two or three years.
Employment History. Longevity at your job is important to lenders. However, there usually is no discrimination if you have made a recent job change or are a newcomer to the work force. Expect lenders to call your employer to verify the information you provide.
Employment Verification Form. A statement by your employer on company letterhead and signed by your superior may be adequate. However, ask the lender before you go to the trouble of producing this letter.
VA Eligibility Certificate or Form DD 214. You will only need these if you are applying for a VA-guaranteed loan.
Your Building Plans
The lender will want an accurate, detailed set of plans and specifications, a cost estimate, a construction schedule and detailed knowledge of how and what you will be building before processing your loan application. The Design and Pre-Construction sections of this site will help prepare you for this. Information you are likely to need:
Building Permits. Blueprints, designed and drawn to comply with local building codes, will have to be presented to the local building permit office for approval to obtain a building permit.
Sales Contract for the Log Home Package. This should include a complete bill of materials to be supplied by the log home producer.
Plans and Specifications. A floorplan in a producer's catalog is not enough. Bring working plans, detailed materials specifications and descriptions of building materials. With this information, the loan officer will know exactly what he is being asked to finance and can assess its value.
Complete Cost Estimates. You will also need copies of the written bids and estimates you used to compile the detailed cost estimate.
Builder Contract. If you are hiring a general contractor to build the home for you, yo
u must have a copy of the agreement showing costs and specifications.
Survey or Plot Plan. This shows the exact location of your land and provides a legal description of the property.
Deed. This document will show title and mortgage information on land where you intend to build.
Statement of Your Construction Abilities. If you intend to do some or all of the work yourself, supply the lender with information on your qualifications — pictures of projects you have completed, if they are available, or other evidence showing you are able to tackle the building of your home.
Information on the Log Home Producer. This can be a copy of its annual report, a catalog, a company brochure, a construction guide, a copy of its listing in the Producers Directory or anything you may have that explains what kind of home and services you are buying.
When applying for loans, personal documents in addition to those listed above may be requested by the lending institution. If applicable, it is wise to have this information handy:
- Contract for the sale of the house you currently own, or a real estate agent's listing agreement for the house.
- Deeds, mortgages and lease agreements for any rental property you own.
- Your attorney's name, address and telephone number.
- Copies of your builder's risk, liability and fire insurance policies.
- Explanation for any known credit problems or deficiencies.
- Separation and divorce decree and child support decree.
- A copy of discharge of bankruptcy. Provide a list of all secured and unsecured debts covered by the bankruptcy. Be prepared to explain exactly why the bankruptcy occurred.
Loan Cost Disclosures
Since lending institutions may want all of the above information about you and your building plans, it may be a small comfort to know that they are required to inform you of their fees and charges and provide you with a written estimate of all the closing costs associated with the loan. It is important that you ask your loan officer for this information because these charges can be substantial and may vary greatly among competing lending institutions. Basically, you have the right to know how much you are being charged for the loan and all the services that go with it before you sign on the dotted line.
Shop for Your Loans
Buying mortgage and construction money is almost the same as buying a car. An automobile is a commodity and so is money. An automobile dealership sells cars and the bank or financial institution sells money.
The best source of construction financing may not be a bank at all. Some institutions work exclusively with do-it-yourself home builders. Sometimes credit unions make employee loans for home building projects at very favorable rates.
There are about a half-dozen lending institutions that specialize in making log home loans. Most of these companies regularly advertise in Log Home Living and other log home magazines and some are listed in the Suppliers Directory on this web site.
Don't overlook any source for this loan. It is a simple and relatively safe loan with a good return, so many institutions are eager to sell one to you.
Also, look for lending institutions that will grant both the long-term mortgage and the construction loans. When you get separate loans at different institutions, you will likely have to pay many of the closing costs, such as application fees, credit reports and so forth, twice. Doing business with a lender that offers both types of loans can save money.
Talk to your builder-dealer or other general contractors to see where they get their construction money. Builders and lenders we talked with suggest you contact at least six local institutions to get the best terms and interest rates. For more information online, try these sites:
Owner builders might check out this site:
Pay particular attention to fees, charges for inspections and other fees. These items can vary quite a bit between institutions, and they represent a sizeable charge in most cases.
Typical Loan Charges
Loan charges, or closing costs, vary considerably around the country and even from bank to bank in one city. There is enough money involved to make careful shopping a must. Here is a list of costs and charges you should compare before you buy your loan.
Points. Points are a percentage of the loan amount that the bank will charge for making the loan. Points on a typical loan will be 1 to 5 percent, or $2,000 to $10,000 on a $200,000 loan. The number of points charged for a loan will vary from week to week depending on economic conditions and such things as the prime interest rate and the economic forecasts by the Commerce Department. Points are the bank's means of ensuring a profit from the loan in case of rapid economic inflation during the term of the loan. Usually, the longer the term of the loan and the lower the interest rate, the more points you will have to pay.
Application Fee. This fee, which can be up to 1 percent of the loan amount, covers the cost for processing the application and other paperwork associated with the loan.
Appraisal. It is standard practice for the bank to employ a licensed appraiser to establish the value of your home before it makes a loan.
Title Insurance. This protects both you and the lender against errors that could be made in the title search.
Legal Fees. To make sure that the title of your land is clear, some type of legal assistance is required. This may be a lawyer or, in some states, an abstract or title company. The fee pays an expert to research deeds and records at the county courthouse and certify that you have a clear title to the property before any loans are made.
Credit Report. Credit bureaus throughout the country keep files on each of us that record our credit history. These reports are a standard check that all lending institution make before lending.
Inspection Fee. This fee will cover the expense of having an experienced home construction inspector check on the progress of your building work and authorize construction loan draws. Some lending institutions charge per inspection; with four to six inspections required, this can be expensive.
The following costs are not a part of your lender's charges, but are included here so you will be aware that they must be included in your overall cost of building a new home.
Real Estate Taxes. In some states these taxes must be paid in advance and will be prorated for the portion of the year that you own your home.
Recording Fees. These are usually very minor charges the county levies to file all the paperw
ork and make it part of the public record.
Survey. The lenders will want a verified legal description of your property. The only certain way to produce this is to have the property surveyed by a professional, registered surveyor.
Again, these fees may vary considerably around the country, and there may be others that are not included here. The lending institution is required to disclose all of its fees to you at the time you apply for the loan.
Mortgage shopping has become a good bit more complicated because there are so many more types of loans available in today's marketplace. Here's what you need to know before you go shopping for a home mortgage loan.
Down Payment. Lenders would prefer that you have as much of your own money invested in your new home as possible. An 80 percent loan-to-value ratio is a term you'll hear often. It means that the amount of the loan is 80 percent of the value of the home and property, with the other 20 percent covered by your cash or other equity.
If, on the other hand, you just don't have a lot of cash in savings or from the sale of another house, or if you have better uses for your money, you can often get a mortgage with as little as 5 percent down, or a debt-to-value ratio of 95 percent.
The squeeze comes when you calculate the monthly payments. The less money you put down, the larger the loan amount and the higher the monthly payments will be. It's a juggling routine between the costs of the home, the down payment and the monthly payments. Your income, the cost of the home you want to build, and the terms your bank requires are the factors you will juggle to see what you can afford.
Types of Mortgages. Not so long ago, about the only home financing available was a long-term mortgage that had a fixed rate. That is, you borrowed money for 15 to 30 years at a set interest rate. The monthly payments of principal and interest were constant throughout the term of the loan, and it was plain whether or not you could afford it.
During the period of extremely high interest rates in the mid 1980s, mortgage lenders had to invent a whole new set of mortgage instruments to meet market demands. The new mortgages are flexible, creative and adaptable to meet most needs. Here are the major types, even though not all are useful in today's marketplace:
Fixed-Rate Mortgages. These are the standard loans with fixed interest rates and payments that won't change for the entire term of the loan — usually 30 years.
Fixed-Rate Buy-Downs. When interest rates are high, it is possible to buy down the rate on a fixed-rate mortgage. A lump sum of money is paid to the lender at the outset in exchange for a lower interest rate. The amount is pegged to a percentage of the loan amount, say 5 percent, or five points.
Adjustable-Rate Mortgages (ARM). This mortgage product has an interest rate that changes over the years. The plan was approved in 1981 during a period of high interest rates to help applicants qualify for home loans. The loans are offered at a rate lower than fixed-rate loans; however, at certain intervals determined by the lender, the rates and the monthly payments change.
If you're considering an ARM, you'll need to know the caps and the index. The caps are limits on how much the interest rate can vary, both each year and over the life of the loan.
A typical cap might be 2 percent a year and 4 percent for the duration of the loan. For instance, a 30-year ARM made at 7 percent interest with these caps could never exceed 11 percent or fall below 3 percent.
These loans are suited to first-time home buyers who expect to see increased income during the next few years. The bank is protected against rising interest rates while you take some risk that rates will increase. Of course, you benefit if rates should go down.
Graduated-Payment Mortgages (GPM). The basic GPM features payments that increase over a five- or 10-year period. Designed primarily to help young, first-time buyers with rising income, the loans are more expensive than other type loans in the long run. The payments during the first few years cover interest only and the unpaid principal is added to the loan balance in a maneuver called negative amortization. This increases the total payback over the life of the loan.
This type mortgage is a good idea only if rates are excessive and you are certain to have rising income, because the payments will increase, sometimes dramatically, after the initial period. GPM loans are sometimes combined with adjustable interest rates to get a GPM-ARM combination loan that can become quite complicated.