Photo: Adobe Stock by lovelyday12
Once homeowners make the momentous decision to pursue their dream home, the very next thing they should do is surround themselves with a trusted group of advisors—true professionals who know the ins and outs of a construction project. Learning from the experiences of others is key to almost any successful endeavor, and the construction of a log or timber home is no different. This includes your financial partners.
“It’s vitally important to find a financing partner who is experienced in log and timber home lending,” emphasizes Robert Jones, the Executive Vice President of Federal Savings Bank. “The banker provides expertise in the process, explaining how the construction loan works and offering a perspective that minimizes the risks of running out of money, unpleasant surprises, or even failing to qualify for financing.”
Risks like these are avoidable, but not unheard of. Here are some common financing pitfalls to avoid; keep these in mind, and you’ll be well on your way to your dream log or timber home.
1. Not Coming Prepared
Providing the necessary financial information speeds the qualifying process, and being aware of the intricacies of credit and underwriting helps homeowners make informed decisions. For example, debt-to-income ratio is a critical measure of capacity to pay, and knowing that most lenders will limit that ratio to 45 percent of total income helps determine a sustainable loan amount. Banks will also require a borrower to have some equity in the project, either through ownership of the building site, cash injection, or a combination of the two.Further, knowing the impact of credit score and payment history sets expectations. Most banks are fairly rigid in extending construction financing to those whose credit scores are approximately 660 or higher. In addition, understanding the necessity of keeping scores and inquiries constant through the credit process eliminates unpleasant surprises. Avoid taking on any additional credit during the underwriting of the construction loan. Inquiries and additional debt, including credit card applications, car loans, or lines of credit, can lower credit scores, slow the process or even prevent a potential borrower from qualifying for their dream home.
2. Underestimating on Budget
The budget itself is always a critical element of the lending process. Remember to include all expenses that will be incurred. Accounting only for the structure itself in the budget will present problems when the time comes to disburse funds, leaving the borrower short of adequate cash to complete the project. A contingency of at least 10 percent should be considered.One of the most common mistakes homeowners make in the construction process is not preparing for the cost of changes to the original plans, materials, finishes, and fixtures submitted for the project. So-called “change orders” may seem small on their own, but multiple change orders and the associated costs can add up quickly. They can cause a budget to mushroom and send the borrower seeking a possibly painful solution such as tapping into emergency or retirement funds, another loan that must be repaid, or altering certain other aspects of the project to account for the overage.
3. Not Reading the Fine Print
Thinking about both present and future financial considerations is a key exercise in the lending process. Read the documents related to any loan thoroughly, and don’t be afraid to ask questions. Some loan contracts include long amortizations of up to 30 years with either short five-year maturities or interest rate adjustments based on an index. Variable rate versus fixed rate is a fundamental consideration. Evaluate the impact of an increase in interest rate on the loan contract at a given interval and decide whether the fixed rate plan is a better choice. Beware of short maturities and balloon payments. Some construction loans will convert to permanent financing on completion of the six to 12-month construction phase, while others are construction only and will require a payoff via permanent financing. Know the difference.“Many homeowners will only go through the construction of a log or timber residence once in a lifetime,” adds Robert. “While such transactions are a common occurrence for bankers and financing professionals, the experience is extraordinary for the homeowner. So it’s important to do some self-education. Do some research and engage with trusted advisors to relieve the potential for stress or disappointment. The construction of a log or timber home is a process well worth the investment of time, money, and energy. Being prepared can make the journey easier. Knowledge is power.”
With this knowledge on your side, you can take the plunge with confidence and watch that home of a lifetime take shape.
