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Construction Loan Basics
By Mercedes Hayes, Fri Dec 9th
It might not be too big of an exaggeration to say that theconstruction loan is one of the more daunting aspects ofbuilding your custom home. Before we started our project, I hadnightmares about trying to pay two full mortgages at the sametime (our existing and the construction loan), and Ididn't see how it was at all possible. However, the realityended up much more reasonable than I dared hope. COLLATERAL: Many - but not all - companies require youto own your land first before you apply for the constructionloan. That way, if the borrower defaults, the bank has a way torecoup their investment. Some banks will let you roll in theland purchase with the construction loan, but you may have topay a premium. TIMING: Your standard construction loan will be based on the oneyear plan. It's perfectly reasonable to expect to finish withina year, unless you are building a handcrafted log home. The goodnews is that you aren't obligated for the full construction loanamount from day one. You only have to pay interest for theamount of money you actually borrow from each draw. So you won'treally be carrying the full until the end ofconstruction, at which point you will roll the construction loanover to a conventional mortgage.
BUDGETING: Before you apply for the construction loan, you mustget all your quotes in order. Banks are not happy aboutincreasing the amount of money you ask for. Be sure to accountfor all the sub-contractors (plumbers, masons, electricians,excavators, landscapers), the well and septic, the windows androof, the painters, and even the grass seed. Your mortgagerepresentative will expect you to have a handle on all yourfinancial needs (see my article BREAKING DOWN THE BUDGET OF YOURLOG HOME for more specifics). If some of these expenses will beout of pocket, it wouldn't hurt to include them in yourconstruction loan request anyway, so you have a cost overrunbuffer. And get more than one quote if possible, then use thehighest quote in the construction loan request. If you go withthe lower quoted job, you'll have another buffer in your favor. Before the company agrees on the loan, they willrequire a copy of the floor plan, permits, and survey. Then theywill send out an appraiser who will inspect your property anddetermine whether your project will appraise for the amount ofmoney they are committing to. Luckily, more and more banks aregiving log homes a fair appraisal, but it helps to choose acompany that specializes in log homes or your market value maycome in too low. DRAWS: When you've itemized your anticipated expenses, you canshare this with your rep., who will then ask you howyou would like to break down the
disbursements (or "draws" as wecommonly know them). This will be your decision (with a littlehand-holding). At first, you might want to schedule a coupledozen draws, until you realize that there is a service chargeattached to every draw. For instance, every time the bankreleases a draw, you have to notify them a few days in advance.The bank sends out an inspector to verify that the promised workwas performed. Then they order a Title Search to verify that youhaven'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 tobuilding a log home. Normally, banks release a draw after thework has been completed. However, log home manufacturers requireCOD when the logs are delivered (or ideally the day before).Historically this had been a bone of contention between thebanks and manufacturers, until certain banks took the lead andset up accounts directly with the log home companies. Thisexpedited the whole process. These direct deposits become drawson your construction loan. EXAMPLE: In our case, we ordered a total of 11 draws. Onsettlement of the construction loan, the bank started us withabout $38,000 for misc. expenses. We used much of this to bridgethe gap between draws (the contractors want to get paidregularly). There was a draw for the Log Kit deposit. There wasa draw for our Superior Walls precast foundation (another directdeposit). Another draw paid for the COD log delivery; anotherdraw paid for the window delivery. Then things got moretricky, because the next draw covered the well and septic, whichhad to be completed first. Once the log walls were raisedanother draw came, another when the "weathered-in shell" wascomplete, and another draw when the mechanicals were installed.The last draw came at the end of the project, but the bankwouldn't release the money until we had stained the house andplanted grass seed. They wanted to make sure the house was readyfor 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 havesome extra money set aside, your contractors might quit workinguntil they get paid, knowing full well that you won't get paiduntil the work is finished. Coffee and donuts help to keeprelations smooth, but nothing works like cash. And remember: if by some miracle you don't use all the money yourequested in the construction loan, you can always give the restback. So don't cut corners. Estimate high, spend less, and youjust might have enough left over for that luxury item you alwayswanted. About the author:Mercedes Hayes is a Realtor licensed in New Jersey andPennsylvania. I specialize in Log Homes and Residential RealEstate. For more information about myself and the DelawareValley, go to www.MercedesHayes.com
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