Financing
Tue, Dec 5, 2017Financing a vacant piece of land is not easy. If you are trying to get a loan for such a purchase, they are called lot loans. Many banks, at least at the time, were not offering such loans. For the ones that were, they were often adjustable rate, high interest, and required large down payments. Given that we had increased the budget on the land so much, having this higher than expected interest rate was causing some anxiety.
The other option was to do seller financing. This is where the seller acts as the lender. It is very common for sellers to offer seller financing in this area, due to the difficulty in acquiring financing. However, seller financing often meant even larger down payments, and higher interest rates. We weren’t really in a buyers market, so asking for this kind of concession wasn’t guaranteed.
We’ve been looking into financing for a bit and already have a good lay of the land. We’re able to put as much as 30% down, but want to put down as little as possible so that we can save for the construction, which we are also considering financing. If we have extra cash at the end of construction, we will pay down the loans with the remaining balance.
If lot loans are difficult to come by, construction loans are even more difficult. A construction loan is a loan you get for constructing a house. The bank will approve you for a certain dollar amount, based on the expected budget to build the home.
The funds from the construction loan are not given to you at the start. Instead, you must pay for expenses out of pocket, and each month, the bank will send out an inspector to inspect and approve work completed. The bank then reimburses you for any work they approve. So you can expect to have to float expenses for at least 60 days. Additionally, you need to organize your budget in a way that allows you to say you completed a task. For example, if your line items is ‘kitchen’, and you installed kitchen cabinets this month, the bank won’t reimburse you for the kitchen expenses until the entire kitchen is completed. This incentivizes you to create a fairly granular budget, which is a good thing.
As we started to get deeper into the terms of these loans, we found that no one would give a construction loan to an Owner-Builder — an owner who was going to build themselves, or at least oversee the construction. These banks wanted a General Contractor to oversee all construction. Building it ourselves was the whole point of this project! This was a major setback, and took the list of two banks we had been talking to, down to zero!
We got a callback from our rep at US Bank (who we were still discussing a lot loan with), and she recommended we reach out to Washington Federal. She had worked there prior and was aware that they provided owner-builder construction loans.
My brother followed up in person the next day and talked with a gal at one of their branches. They indeed provided owner-builder construction loans, assuming you had some demonstrable proof that you could manage such a project, and even better, their rates were really good (just a little higher than a primary residence 30-year fixed). The construction loan automatically rolled into a 30-year fixed at the end of construction, and you could use the construction loan to purchase the land too.
We got in touch with the local Cle Elum branch, who would service the loan, and got more specifics on the terms. We could lock in the rate today, and that would be our rate once the loan rolled over to a traditional 30-year fixed at the end of construction. That was good, because at the time, rates were very low, and were expected to rise soon.
We would have 12 months to complete construction. That is from the time we close on the loan, to when the county and bank approve for habitability. This was a huge acceleration in the timeline! The HOA required 14 months to complete the outside of the building, but we could spend another two years finishing the inside if we wanted. To have everything done in just 12 months was extremely ambitious. We could get this extended to 18 months for a one-time fee.
The bank would require a letter stating our qualifications to take on such a project. We have never taken on such a large project, but we felt we could meet their requirements. We had helped our dad build his cabin, and had built a few other small houses before, as well as a number of renovation projects and home improvement projects. They would also want to see a detailed budget (was already working on this with some excel magic), a room by room description of materials, and all building/construction documentation.
A build permit has to be on-hand prior to applying for the loan. This would be tricky since we did not have one for either lot. In fact, the county would not let us apply for a build permit unless we owned the land. A chicken and egg problem…
They wanted 25% down. But this was for the lot and the construction costs, which meant the down payment would be much larger than if we did just a lot loan. Remember that once we have the construction loan, we need to be able to float expenses for about 60 days too. The bank will want to see enough cash on hand to accommodate this. Framing, one of our largest expenses, would likely be completed in a 60 day period, so we needed to account for all our lumber and framing labor as cash on hand, in addition to that 25% down. Since we’d be parallelizing as much work as possible, we’d probably need to have even more cash on hand.
Trying to roll the lot and construction loan into one was starting to look rather impractical. Not to mention this wasn’t something I wanted to rush. I planned to have this place for the rest of my life, and didn’t want to rush a few decisions to make a bank’s artificial deadline.
So a plan formulated. We would purchase the lot with a 3⁄1 ARM lot loan, get our permit and plans in order, perhaps do a bit of construction to give ourselves a head start on that timeline, and then apply for the construction loan.
Something we found out later is that we can apply construction expenses accrued prior to the construction loan, towards the construction loan down payment (assuming you have the proper receipts). So if we spent $30,000 on our foundation, and then applied for the construction loan, we could subtract $30,000 from the down payment. This is a really powerful feature of the construction loan. It essentially allows us to pursue construction, up to the amount of the down payment, on our own timeline prior to the banks 12 (or 18) month clock starting. In fact, we can even spend more than the amount of the down payment, and get a reimbursement draw after the first month of the loan.
Doing all this research took about two months. This was actually the first thing we started doing prior to looking at lots. It is not fun, but it’s worth exploring all the options as it can save you a lot of money in interest, closing costs, etc. It’s not always possible, but its extra worthwhile when you have a good agent to work with. US Bank was pretty helpful in their guidance, and the folks at Washington Federal spent quite a bit of time walking us through the various options and their terms.
Now all we have to do is decide on the lot, and I think I know what to do there.
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