Financing a home you plan to have built on your land is different from financing a pre-existing home. With a pre-existing home, the 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 serves as collateral for the mortgage.
Financing a home you plan to have built on your land is more complex because there is no existing home to serve as collateral. The lender only has the "potential" that when construction is completed, an asset of collateral value will exist. Construction loans are made on the basis of the builder's "potential" to create an asset. Knowing this, it is easy to understand why bankers often are reluctant to make construction loans to people with builders who have no practical building experience.
Construction loans usually cover up to 80 percent of the appraised value of the home and land or 100% of the actual construction cost, whichever is lower. If you already own the land free and clear, it can count toward the down payment for construction. There are generally two different types of construction loans that the banks will provide. The traditional is the standard construction loan where you have two separate closings - the first in the beginning of construction and the second when construction is complete. Most banking institutions also offer a one step construction loan with one closing after construction is complete. After this closing, the loan goes to principle and interest payments.
Unlike mortgage loans, construction loans are released in the form of "draws." The money is paid out by the bank in exchange for proof - usually paid invoices - that labor and materials were used to build the home being financed. In effect, you are being reimbursed for work that is already completed. In most cases, banks will not pay out more than the amount of the bid for the work in question, and will inspect the work to ensure good quality.
When you start to draw on the construction loan, you'll have to make monthly interest payments on the money that actually left the lender. You will also pay fees for inspections, the administration of the loan and payments on draws.
Qualifying for a construction loan is dependent upon, and basically the same as, qualifying for a mortgage. Once the mortgage loan has been approved, bankers normally will go along with a construction loan because they will get their money back when the mortgage loan takes effect. Getting a mortgage commitment first will save time and money on credit checks, etc.
Before granting either loan, financial institutions want to be sure the money you borrow will be returned in full with interest and at little risk to them. They want to be sure the home is worth at least as much as they have risked. To help secure the loan you will have to provide the following information:
- A completed loan application form
- A personal financial statement
- An employment verification form
- A building permit
- A sales contract with specific prices
- Detailed plans and specifications
- Written estimates/bids from contractors
- A complete cost estimate sheet
- A survey and plot plan
- Building department approval document
- Title to the land
- Information about your log or timber home producer
- Cost information on comparable log or timber homes
- A statement of your construction abilities if you intend to build yourself
For work you are planning to do yourself, you should still get written estimates from subcontractors for labor and materials so your lender will know the project's full value, and you'll know your labor equity contribution. If something should happen to you, the funds will be there to finish the project. Remember, with a construction loan, you pay interest when the draw is made. So if you plan to stain your home yourself, the value will be there even though you contribute the labor.
These details are necessary. Lenders will not give out thousands of dollars to someone without building experience. Unless you are a contractor, a builder, or have vast experience in the building field, they will not approve the loan because of the risk. The biggest fear of lenders is an uncompleted project worth a quarter of the amount loaned out. They want to invest in professionals who will get the job done right.
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