Understanding Mortgage Economics

It's definitely rough out there. But you already knew that from the vast media coverage surrounding the issue. Rather than taking everything we read at face value, though, we decided to do a little digging of our own, chatting with various builders, log providers and lenders about their perspective of the market. Here are the top six things we took away from those conversations.

1. This type of market is unprecedented.
"Housing is in the worst downturn that we've seen since the 1980s," says Jim Young, president of PrecisionCraft Log Homes and co-president of the Log Homes Council. "It's difficult for all builders out there. Typically, the log-home industry does better than the housing industry as a whole — and we're seeing that — but it's still a painful time for us."

The log-home industry is off between 20 to 30 percent from last year, and unlike prior industry dips, this drop is affecting all tiers of the industry, including the luxury market, which is unusual, says Jim. "In the past 15 years, the luxury group has been insulated from downturns. That's not the case this go-round. The stock downturn has affected those higher-income individuals," he notes.

"I have never seen it this complex," says Mike Stone, president of Old Dominion Custom Homes. "It's encroached on us from all sides."

"A lot of people don't know what to do," he adds. "They're just hoping to get through this mess." Because of the slowdown, companies are taking on projects they normally wouldn't, he says, stating his company has taken on some remodeling jobs to stay busy, while others are broadening their businesses to encompass a greater range of interests.

But many are sitting on their cash — refraining from big-ticket spending such as business expansion or new equipment — which "is prudent but also part of the problem," Mike notes. "And prospective clients are doing the same."

What you can do:
Think aggressively. This is a no-brainer. Log-home companies need projects to stay in business. And what better way to attract customers than to offer discounts and incentives? If you do your homework — i.e., check for references, contract with a reputable builder or manufacturer, etc. — you should come away with great quality at a much more affordable price than in previous years.

2. All regions have been affected differently.
The severity of the market downturn varies by region. "The hot spots for the past seven years — such as Florida, Arizona, Nevada, California and Virginia — saw home values appreciate more than 100 percent during the boom," says Doug Groff, president of American Log Mortgage. "They've been hit the hardest by the downturn. This correction has meant declines of around 10 or 11 percent. But areas such as Tennessee, North Carolina and South Carolina, which only saw homes appreciate about 10 to 11 percent during the boom, are still seeing 2 to 3 percent appreciation now."

Likewise, builders with varied regional exposure have been affected differently. Manufacturers that only operate in one or two areas will likely feel the pinch more, notes Rob Cantrell, president of StoneMill Log Homes and co-president of the Log Homes Council, whereas companies that have a broader geographical range are better leveraged to take advantage of less-affected areas.

International interest — although more popular when the dollar was weaker, providing those customers access to better pricing — is giving some companies a boost, Mike notes, with projects in Switzerland and Japan.

What you can do:
Streamline your building schedule. During the height of the market, it may have been difficult to find a company that would be able to build your home exactly when you needed it because of high demand. But in a market like this, notes Mike Stone, president of Old Dominion Custom Homes, you can dictate your time line because contractors aren't managing as many projects.

3. "Log home" doesn't equal "sub-prime lending."
Sub-prime lending never really hit the log-home industry. "One of the positives is our customers are typically not sub-prime borrowers," says Rob. "They tend to be more financially stable than stick-built customers." The industry never hit the highs that stick builders hit, either, Rob notes, and, therefore, won't experience quite the same lows as the economy waivers.

Plus, "there aren't usually first-time buyers in log homes," says Mike. Log homes are typically reserved for retirement or dream abodes, so people have adequately prepared to finance them.

Low default rates should bode well for value going forward as well. "I see the log-home industry as being separate from the general housing market because the borrowers, or owners, are enthusiasts," notes Troy Kennedy, a home mortgage consultant and log-and-timber team leader at Wells Fargo. "The default rates have been a lot lower, so log-home values will remain more stable."

Although most traditional lending products are still readily available, some lenders have backed away completely from construction-to-permanent loans — one of the fundamental lending products of log-home building — because of the perceived risks involved. Manufacturers need payment before they deliver the logs, so a significant amount of upfront cash is required from the lenders before they actually see a product. This front-loaded draw schedule makes perfect sense, says Doug, "but if you don't understand it, it could be seen as risky."

Such lending is still conservative in comparison to risky products such as adjustable-rate mortgages and amortization mortgages, Troy notes. "We're not seeing that fallout," he adds.

What you can do:
Hunt for low interest rates. Although not at rock bottom, interest rates for loans are still hovering near historic lows. According to Doug Groff, president of American Log Mortgage, as long as you have good credit and can provide solid, verifiable sources of income, there are plenty of options available.

4. There's still money out there.
"There are so many misconceptions floating around," says Troy, adding that it's still business as usual with Wells Fargo in terms of mortgage lending, albeit with a few more restrictions. "In general, lending requirements are more conservative. But we're still lending up to a 90 to 95 percent loan-to-value ratio for mortgages and 85 percent loan to value on construction-to-permanent loans." (The loan-to-value, or LTV, ratio refers to the loan amount needed as compared to the assessed value of the home.)

The only thing that's really changed, Troy says, is that full documentation is now required, meaning borrowers need to present pay stubs, bank statements and other basic financial documentation to confirm their income instead of just listing an estimate for lenders. A reserve of 10 percent also is required to make sure borrowers aren't completely wiped out after closing. These reserves can include assets such as stocks and bonds or 401K accounts.

One of the issues that has arisen, however, is trouble qualifying for a loan after construction. "After one year, credit documents may expire," explains Troy. "If the loans extend beyond that, it used to be no big deal. But nowadays, with home values going down and more stringent loan criteria, such loans may need to be restructured to fit new guidelines."

Another financial obstacle holding potential customers back is selling their primary residence so they can build their dream home. But even that issue can be alleviated with some creative options, Doug notes, such as leasebacks or rent-to-own setups with prospective buyers, depending on the financial status of the new owner in question.

Either way, the issue isn't about not having money to lend. It's about safely lending it.

What you can do:
Perfect your credit score. More than ever, mortgage companies are paying close attention to your credit history. Go over this score, correct any discrepancies, and keep things squeaky clean until it's time to buy your home. (See "Are You Credit Worthy?" below.)

5. Land is holding its value.
You can't build your dream home without land on which to construct it. And like the overall housing market, sales of rural land are also seeing a slowdown. "The number of transactions has dropped considerably," says Jake Massengale, CEO of LandsofAmerica.com, an online rural real estate company. And although no hard data are available yet for 2008 rural land sales, it's easy to say days on the market have gone up drastically as well, he says.

But the land value is still there. "A big advantage is that rural land is a true commodity," Jake notes. "People want a tangible asset. That's what has kept the prices from really dropping." That's not to say you can't still find a good deal or two out there. "The best advice I can give to prospective buyers is don't be afraid to make offers," Jake says. "Most land parcels sell 10 to 20 percent below the listed price. Just because the sticker price is higher than what you intended, don't rule out that property."

What you can do:
Bid low on land. Not building for a few years? You're in no hurry — and many sellers are. By not being desperate for your slice of paradise, you'll most likely have the freedom to search long and get a great deal. Hint: Buy land relatively close to towns and other essential services. Extremely remote dwellings seem idyllic…until you want to eat out, see a movie or need a doctor.

6. This situation isn't permanent.
"There's definitely still demand — no question about that," says Rob. "But people are still hearing bad news in the media almost daily, so they're moving slower. A lot of people are taking a wait-and-see attitude. But our customers will start to move forward before the rest of the industry."

That bodes true in the financial market as well. "When borrowers get over the media misconceptions and realize rates are phenomenal, the log-home market will improve more quickly than the general marketplace," echoes Troy.

But there's no crystal ball to say when this will occur. Both Rob and Jim note that 2009 will likely be another lean year, with Rob anticipating better predictability at the end of this quarter. And for log-home enthusiasts pursuing their dream, the days of a conservative marketplace aren't a bad thing — they're merely a return to normalcy. It also makes the accomplishment of building a custom home that much more satisfying.

What you can do:
Seek quality craftsmanship. Quality is something every log-home owner strives for when building his or her dream home. With fewer projects in the works, however, many quality craftsmen are looking for work, compared to two or three years ago. So get them now while you can.