CONSTRUCTION LOAN BASICS


Author: Mercedes Hayes


It might not be too big of an exaggeration to say that the
construction loan is one of the more daunting aspects of
building your custom home. Before we started our project, I had
nightmares about trying to pay two full mortgages at the same
time (our existing mortgage and the construction loan), and I
didn't see how it was at all possible. However, the reality
ended up much more reasonable than I dared hope.

COLLATERAL: Many – but not all – mortgage companies require you
to own your land first before you apply for the construction
loan. That way, if the borrower defaults, the bank has a way to
recoup their investment. Some banks will let you roll in the
land purchase with the construction loan, but you may have to
pay a premium.

TIMING: Your standard construction loan will be based on the one
year plan. It's perfectly reasonable to expect to finish within
a year, unless you are building a handcrafted log home. The good
news is that you aren't obligated for the full construction loan
amount from day one. You only have to pay interest for the
amount of money you actually borrow from each draw. So you won't
really be carrying the full mortgage until the end of
construction, at which point you will roll the construction loan
over to a conventional mortgage.

BUDGETING: Before you apply for the construction loan, you must
get all your quotes in order. Banks are not happy about
increasing the amount of money you ask for. Be sure to account
for all the sub-contractors (plumbers, masons, electricians,
excavators, landscapers), the well and septic, the windows and
roof, the painters, and even the grass seed. Your mortgage
representative will expect you to have a handle on all your
financial needs (see my article BREAKING DOWN THE BUDGET OF YOUR
LOG HOME for more specifics). If some of these expenses will be
out of pocket, it wouldn't hurt to include them in your
construction loan request anyway, so you have a cost overrun
buffer. And get more than one quote if possible, then use the
highest quote in the construction loan request. If you go with
the lower quoted job, you'll have another buffer in your favor.

Before the mortgage company agrees on the loan, they will
require a copy of the floor plan, permits, and survey. Then they
will send out an appraiser who will inspect your property and
determine whether your project will appraise for the amount of
money they are committing to. Luckily, more and more banks are
giving log homes a fair appraisal, but it helps to choose a
company that specializes in log homes or your market value may
come in too low.

DRAWS: When you've itemized your anticipated expenses, you can
share this with your mortgage rep., who will then ask you how
you would like to break down the disbursements (or "draws" as we
commonly know them). This will be your decision (with a little
hand-holding). At first, you might want to schedule a couple
dozen draws, until you realize that there is a service charge
attached to every draw. For instance, every time the bank
releases a draw, you have to notify them a few days in advance.
The bank sends out an inspector to verify that the promised work
was performed. Then they order a Title Search to verify that you
haven't had any liens put on your property since the last draw
(this costs about $125 each time).  

This leads us to the next issue that pertains especially to
building a log home. Normally, banks release a draw after the
work has been completed. However, log home manufacturers require
COD when the logs are delivered (or ideally the day before).
Historically this had been a bone of contention between the
banks and manufacturers, until certain banks took the lead and
set up accounts directly with the log home companies. This
expedited the whole process. These direct deposits become draws
on your construction loan.  

EXAMPLE: In our case, we ordered a total of 11 draws. On
settlement of the construction loan, the bank started us with
about $38,000 for misc. expenses. We used much of this to bridge
the gap between draws (the contractors want to get paid
regularly). There was a draw for the Log Kit deposit. There was
a draw for our Superior Walls precast foundation (another direct
deposit). Another draw paid for the COD log delivery; another
draw paid for the window delivery.   Then things got more
tricky, because the next draw covered the well and septic, which
had to be completed first. Once the log walls were raised
another draw came, another when the "weathered-in shell" was
complete, and another draw when the mechanicals were installed.
The last draw came at the end of the project, but the bank
wouldn't release the money until we had stained the house and
planted grass seed. They wanted to make sure the house was ready
for sale. 

With luck, you won't be delayed by weather or on-site errors,
which could derail your whole plan. However, if you don't have
some extra money set aside, your contractors might quit working
until they get paid, knowing full well that you won't get paid
until the work is finished. Coffee and donuts help to keep
relations smooth, but nothing works like cash.

And remember: if by some miracle you don't use all the money you
requested in the construction loan, you can always give the rest
back. So don't cut corners. Estimate high, spend less, and you
just might have enough left over for that luxury item you always
wanted.

About the author:
About the author: Mercedes Hayes is a Hiawatha Log Home dealer
and also a Realtor in New Jersey and Pennsylvania. She designed
her own log home which was featured in the 2004 Floor Plan Guide
of Log Home Living magazine. You can learn more about log homes
by visiting www.JerseyLogHomes.com.

 

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