As you begin the process of financing your Log or Timber Frame home, you will find that there are some differences compared to financing a conventional home. The following is a list of things to consider:
- As you interview lenders, look for a loan officer who is experienced in Construction lending. Even more importantly, make sure the lender is experienced in Log Home and Timber Frame construction lending. You may have many questions during the process and you will want to deal with an expert that you can rely on.
- What is the lender’s policy as it relates to paying the required upfront deposit as well as the final payment to the Log or Timber Frame company? You will find that many lenders shy away from financing these types of homes because they are not comfortable paying out monies before materials are on site. Alternatively, the Log and Timber Frame companies require a down payment to begin milling the logs or timbers. Keep in mind that the log or Timber Frame package is unique to each client’s project. The down payment deposit is your “good faith” commitment towards purchasing that package. Unless you have the financial wherewithal to pay these monies out of pocket, you will want to be sure your lender will accommodate the required payment terms of your Log or Timber Frame Company. Understanding this upfront can save many challenges later in the process.
- During your research, you will find that lenders offer two types of Construction loans. I refer to the first as a “Two-time Close,” which means the lender will provide you with a construction loan that will need to be refinanced into a new permanent mortgage loan once the home is completed. This type of transaction requires that you re-qualify for the new permanent mortgage and it also requires that you pay two sets of closing costs. A less expensive approach may be a “One-time Close” loan. In this situation, the lender provides one loan for the construction period. When the home is complete, the loan will automatically convert to a permanent mortgage. Lenders policies vary, but for the most part, this type of loan will not require you to re-qualify or pay new closing costs when the home converts to the permanent mortgage. Typically, during construction, you will pay an interest only payment based on what you owe each month. As your balance increases, so will your monthly payment. When the home is complete, you will begin to pay a Principal, Interest, Tax and Insurance payment (like that of a normal conventional loan). Construction loan terms vary from 6 months to 12 months and beyond. Check with your lender.
- Once you have determined which lender you will use, it is recommended that you apply for your financing early on in the process. Understanding how much you can qualify for up front will aid in your discussions with your Log or Timber Frame company as well as with your builder. Most lenders do not charge for a pre-approval.
- Understanding the real estate market in the area that you are going to build can be very useful. It’s important for your lender to know if your new home will be marketable in your area. For instance, here are some items to consider sharing with your lender: Is the size home you are considering building in line with other homes in the area or will it be an over-improvement or an under-improvement? Does your property include acreage and if so – how many acres? Is this typical for the area? Is the property zoned agricultural and is there anything growing on the site? Are there other log or Timber Frame homes in the area or will your home be the first? Are you considering an alternative approach to power (i.e.; solar)? It’s critical that you discuss these items with your lender up front. It can save you from challenges late in the processing of your loan.
- What type of down payment is going to be required? You will find that each lender has different policies. Most lenders will require a 5%, 10% or 20% down payment (down payment percentage is typically determined by your loan size). This means 5% to 20% of the overall project cost (land plus construction costs of the new home). As an example, if you are purchasing the land with the construction loan, you would add the purchase price of the land to the budget (cost breakdown) for the home. You would be required to bring cash to the loan signing of 5% to 20% of the total amount. If you own the land outright, the equity in the land would most likely count towards your down payment needs. In this scenario, you may not be required to bring any cash to the loan signing. The equity in the land may already be your 5% to 20% (or more) down payment. If the land equity is sufficient, you may be able to finance the closing costs into the loan as well. Discuss your scenario with your lender up front to determine if you will be expected to bring any cash to the loan signing.
- Are you considering beginning any construction work on your site prior to loan signing/closing? Pre-start activity is generally acceptable, but you should check with your lender before beginning any construction work on the property. There may be a challenge with the Title Company insuring the lender if any work has begun prior to the loan signing. If it is determined that it is acceptable to begin work ahead of time, keep good records of anything you pay for out of pocket. You may be asked to prove payment for these items. A copy of the Invoice and canceled check or credit card receipt should suffice. Any payments you make ahead of time should also be credited towards your down payment needs (listed in # 5 above). Once your initial down payment is made, any excess items paid for may be able to be reimbursed to you at the loan signing. Discuss this with your lender to see if you can be reimbursed for any of these items.
- What happens if your costs exceed your original budget? This is a common occurrence with construction projects. The excess can be caused by something outside of your control or can be caused by an upgrade that you make along the way. Either way, if there are not sufficient funds in the loan to pay for the overage, then you must pay for it with your own cash. Perhaps a better way to handle this would be to build a contingency factor into the loan amount. This is accomplished by increasing your loan amount for potential cost overruns. A good rule of thumb is to build in 5% to 10% of the budget as a contingency factor. This is all possible as long as the appraised value of the property supports the extra dollars requested in the loan. Typically the lender will not require that you use the contingency dollars. It is only there for you should you need it. Ask your lender to explain their policy on the use of contingency dollars.
- Is Interest Reserve an important feature for you with the construction loan? Interest Reserve is a dollar amount that is added to your loan and is used to make your monthly interest payments during construction. Instead of writing a check each month for the interest that is due, the payment is taken out of your loan and made for you. During construction you actually make no monthly payments. At the end of construction, you owe more money because you have borrowed those monthly payments using the loan proceeds. This feature is not important to everyone. It may be useful for a client who wants to sell their current home, but would like to live in this home while the new home is being built. Making two house payments on a monthly basis may be a challenge while the other home is trying to be sold. Having an Interest Reserve could be a nice feature in this scenario.
- Are you considering being an Owner Builder? Being involved in the building of a Log or Timber Frame home appeals to a lot of people. If you are considering overseeing or actually doing some of the construction work on your own, please discuss this with your lender up front. Some lenders will want to be sure that you are experienced enough to oversee the project. You may be asked to provide a resume of your experience as it relates to construction. Other lenders may not allow you to be an Owner Builder at all. Be sure your lender will accommodate this for you.
This article was written by Paula Murtha with MetLife Home Loans. For more information on log home financing, please contact Paula by email at firstname.lastname@example.org or call (720) 489-4891.