Your Construction Loan
A short-term construction loan provides the funds to build the house and when it is complete that loan is replaced by a permanent mortgage.
The loans may be from separate lenders, or one lender may make both loans. Often a lender may combine the two loans in the form of a combination loan. It is the same as two loans, but you only have one closing and it converts automatically to a permanent mortgage. You can save on closing costs and hassles, but you could lose the freedom of shopping for another lender if rates change appreciably during the time of construction.
A construction loan is doled out in partial payments to the builder as the work progresses. You will not receive any money in advance, so plan to have sufficient cash on hand to pay for construction up to the first draw.
Often these draws are dispersed after visits by the lender’s inspector to verify that each phase of construction is finished. They correspond with the stages of construction such as foundation, rough framing, rough electrical and plumbing, etc.
For example, one lender uses the following draw schedule for kit built homes:
- 1st draw 15% Foundation and floor complete with rough plumbing
- 2nd draw 30% House package erected with interior framing
- 3rd draw 20% Rough electric, plumbing and A/C ducts installed
- 4th draw 20% Exterior and interior walls completed, cabinets and vanities installed
- 5th draw 15% All remaining improvements completed and improved
A construction loan is typically for 6 months to a year with a usual rate a few points above the prevailing prime rate. In addition to interest payments, there are one time up front service charges, usually several points. You pay monthly interest charges as they accrue, and the loan has a balloon payment of all the principal at the end of the term, which is paid by the permanent mortgage.
Lenders may take one of two approaches to figuring interest. There is a difference, so check to see which method each lender uses, so you may comparison shop.
- Interest is paid monthly based on the entire loan amount from the day the loan is granted.
- Interest is calculated only on the amount drawn. For example, if only 1/10th of the loan amount has been drawn, then you only pay interest on 1/10th of the total loan amount. Preferable, if you can get it.
If you are considering building your dome yourself, lenders will feel they are taking on a bigger risk, so they will be even more reluctant to grant you a loan.
They would feel more comfortable with a contractor that would guarantee a fixed cost and completion date. In some states it is not too difficult to become a contractor and form a company. If the idea of becoming a builder interests you and you end up with dome building experience, list your name with the kit manufacturer who likely knows others who need their dome built.
Avoid a common contractor/builder trap:
Not having enough money to complete each stage of construction so the lenders will issue the next draw (check).
The lenders dole out the loan after the work is complete. The catch is to have sufficient cash and resources to assure that each phase is completed. Be sure that you understand the lenders draw schedule and that wishful thinking does not lure you into unrealistically low cost estimates. See sample Draw Schedule on page 16. If you find this to be too rocky a road, you may wish to stick with a contractor or pursue alternatives such as family financing, stage financing, or bootstrap financing.
Mortgage lenders require an appraisal to help them determine how much your property will be worth once your new home is completed. The appraiser will make a judgement as to the value of your completed dome based on many factors including:
- Market value of the homesite based on zoning and sales value of comparable properties in the neighborhood
- Improvements to the property such as fencing, ponds, docks, outbuildings, or extensive landscaping
- Advancements available to the homesite such as sidewalks, drainage, streetlights, or fire hydrants
- Type of construction
- Square footage of living and utility areas
- Luxury fixtures included in construction
- Quality of construction
- Marketability and sales price of the completed home and property if the lender must take possession
If possible obtain one appraisal that is acceptable to all the lenders you are considering. A single appraisal will save you time and the extra expense of duplicate appraisals. An appraisal from a designated professional appraiser, such as an SRA or MAI, will be the most comprehensive and most widely accepted, but may also be the most expensive.
It is also very important that you select the appraiser and spend whatever time it takes until you get someone who has a positive attitude about domes. After you have paid your money, you don’t want to find out that they are as resourceful as a square house. A pessimistic appraiser can kill the whole deal. Ask what they will do about comparables and assist them in locating unique houses in your area.
Many appraisers find it difficult to establish a market value on a dome house. They may also believe that it is necessary to have a “comparable” sale of another dome in your area. Fannie Mae (see Secondary Mortgage Market” page 22), the nations largest source of home mortgage funds, gives special consideration to unique housing.
Be sure your appraiser is aware of the Fannie Mae “Selling Guide” manual concerning unique housing. Chapter 4, Section 401.01, pages 755 and 756 explains!
Geodesic domes, etc. are eligible if both the appraiser and the underwriter (lender) determine there is sufficient information to develop a reliable estimate of market value. It is not necessary to have comparable sales of other domes if the appraiser is able to determine sound adjustments for the difference in the homes used for comparison; he can demonstrate the marketability of the dome based on older sales. Sales in competing neighborhoods or the existence (without a sale) of similar homes in the area, or any other reliable data. For a list of Fannie Mae mortgage lenders in your area, call 1-800-732-6643. Avoid lenders that sell their mortgages to Freddie Mac, because their appraisal guidelines are more restrictive.
YOUR MORTGAGE & THE U.S. GOVERNMENT
Without being a mortgage company making direct loans, the federal government plays a major role in home financing. Through broad, powerful legislation and many government and government sponsored agencies, it carries a great deal of influence over many of the details and requirements of your home mortgage.
Congress passed the Real Estate Settlement Procedure Act (RESPA) in the mid-1970’s to protect mortgage borrowers. Under this legislation the lender must provide you with certain information after loan application, including a good faith estimate of your settlement costs. After closing they must provide a uniform settlement statement which itemizes those costs.
The Truth-In-Lending Act requires lending institutions to give borrowers complete information on the real cost of borrowing money. They must provide you with a truth-in-lending statement outlining all your costs connected with obtaining and maintaining your mortgage and any penalty payments.
Fair Credit Reporting Act
The Fair Credit Reporting Act assures that you can review and challenge your credit report and request inaccurate information be corrected.
The Equal Credit Opportunity Act
The Equal Credit Opportunity Act prohibits lenders from discriminating against you on the basis of race, color, religion, national origin, sex, marital status, age, or because income is from any public assistance program.
Your mortgage could be obtained through one of the many programs offered by the Federal Housing Administration (FHA).
Although your local lender does the actual lending, the federal government gives the lender insurance or guarantees.
Secondary Mortgage Market
Government agencies also affect the mortgage process by the creation of a cycle of funds, which keeps money circulating through the financial marketplace so that more loans may be made. Federally sponsored agencies, the Federal National Mortgage Association (alias Fannie Mae), the Government National Mortgage Association (alias Fannie Mae), and the Federal Home Loan Mortgage Corporation (alias Freddie Mac) purchase mortgages from lenders.
The lenders are then able to make more mortgages, which results in more homes being built. The lender benefits because they can make more profit and have the ability to increase their cash reserves on short notice. The borrower benefits because a steady supply of mortgage money is available. Investors benefit because they can buy securities backed by the mortgages from the government agencies in an open market.
The lenders must conform to the requirements regarding loan application practices and qualifications if they want to sell their mortgages in this huge secondary mortgage market. So when they consider granting you a mortgage, they will compare the qualifications of you and your dome against the agency’s guidelines.
Since your mortgage will probably be sold in the secondary mortgage market, your lender will follow the guidelines of the agency(s) buying their mortgages. Their underwriting guidelines specify numerous conditions and requirements of the mortgage, including the appraisal.
FINDING THE RIGHT MORTGAGE LENDER
If you will be building your new dome with a mortgage, arranging for financing is the primary item on your list. You will want to begin your search as soon as you can. Finding the right lender can be a time-consuming process and you want to be thorough. Once you have blueprints prepared and a homesite selected, it is time to secure a source of funding for the project.
Speak to as many lenders as practical at one time; in particular contact small local banks and local credit unions. You wouldn’t want to spend weeks awaiting an answer, find out funds were not available for your type of loan and then have to start over with another lender. Before you pay the application fee, try to persuade the Loan Officer to present your application to the approval committee. Explain that you would not like to pay a fee and have them go through the complete process if the committee will not accept dome housing.
When comparing lenders you don’t have to spend any money to shop around. You can get information about home financing programs to make decisions by simply asking questions over the phone. You should know which lenders have the best programs for you, long before you need to fill out an application and pay an application fee.
Keep in mind that lenders do not loan money on the basis of your need but rather on your ability to repay it. Their prejudice seems to be based on a collective bad experience, always thinking in terms of the worst case scenario: They give you the money, a truck runs over you and you cannot make any payments. Can they sell your unfinished dome? If so, how much and how long will it take?
Be that as it may, it is difficult to argue with them, especially if you are not an experienced homebuilder. They need proof that you are competent, reliable, and trustworthy, and are building a marketable structure you will finish. Just telling them so is not enough they need proof.
Retaining this thought in the back of your mind will help you to anticipate a lot of their questions and, most of all, not to be intimidated or offended by them asking. If you were a lender you’d ask those questions too.
When shopping for lenders avoid focusing on interest rates and losing sight of the big picture. With a $50,000 loan for 30 years, a 1% higher interest rate will increase monthly payments by about $30. If you had to pay an additional $2,000 in closing costs to get 1% lower interest, it would take over 6 years of reduced payments to recover the added cost.
If the lenders with the lower rates decline your application, remind yourself that a higher interest mortgage on a home that you will own is better than rent payments. Also, you would likely save more in heating & A/C costs by owning a dome, than the cost incurred with higher interest rates. Also, refinancing later when the home is complete, property values have appreciated, interest rates are lower, and your credit worthiness improves, will lower your monthly payments.
Your first search for a lender might be the yellow pages under Mortgages, Loans, Banks, and Savings and Loans. They will generally fall in the following categories, although they may not be identified in the phone book.
Operating much like a real estate broker matching up people who want to buy and people who want to sell, mortgage brokers match up people who want to borrow with people who want to lend.
The lenders that the broker represents may be banking institutions, insurance companies, investment groups, or individuals. Since each of them has a different source of funds, they will have different criteria for making loans. They have the advantage of offering the most liberal and flexible conditions.
You will find your most sympathetic ear here, so even at a higher rate it is worth your time.
Differentiate mortgage brokers from all the other lenders in the phone book listed under mortgages. If you can’t tell who is which, call and ask.
While the most restrained in their loan practices, if you have a good working relationship with your bank, don’t overlook them as a valuable source for money or information. Be forewarned that their requirements can be frustrating and discouraging for dome builders.
Unlike commercial banks, they are not involved in deposits from individuals and businesses. They process mortgages, fund the loan and then sell the loan to an Investor.
Savings and Loans
Even though S&L’s have had their ups and downs over the years, they are still the prime source for construction loans and home mortgages. They usually offer some of the best rates and terms, as well as offering governmental backed mortgages such as FHA and VA. But like the banks, their conservative nature can be disheartening.
Home Loan Companies
Operating as personal finance companies to fund projects such as a new pool or bill consolidation, they can be a source for hassle-free construction funds. They usually charge higher fees and interest, however.
Although most of the loans to their members are for cars or furniture, some credit unions are making real estate loans at reasonable rates. If you belong to one, check it out..
BEGIN THE ELIMINATION PROCESS
Let your fingers do the walking as you travel the financing route. Compare lenders by asking them all the same set of questions over the phone.
When you call each lender:
- Have an idea of the type of loan you want…fixed rate, variable rate, 20 year, 30 year…it makes you appear more knowledgeable and conserves their time.
- Ask to speak to a Loan Officer about a new mortgage.
- Introduce yourself and say that you are planning to build a new home soon and that you would like some information on their financing programs.
- Advise the Loan Officer of the type of loan you want and that you would like to ask a few questions to determine if you should pursue the loan with them. Write down the answers for later comparison. Start with:
- What are your current interest rates?
- What are the points charged on the various types of loans?
- Are loans available to owner/builders?
- Do you provide a construction loan?
- Is there a loan origination fee?
- “I plan to build a dome home, will that present a problem?”
- Is there an application fee?
If so, how much?
- “I’m concerned that I could prepare an application, pay a fee and later be declined simply because I’m building a dome. How can I avoid this?”
- Are there other fees?
- Explain to each prospective lender that you want to acquire one appraisal that will satisfy them and the other lenders you are considering. Then ask:
- May I provide the appraisal?
- What type of appraisal is acceptable?
If any of the answers disqualify you, politely explain and thank them for their assistance. If conditions change, you may call again, but for now spend the time looking for your best lenders.
If their answers are acceptable, arrange a time that you can stop in and pick up an application. It is best to fill out the application at home when you have plenty of time. Sometimes they may have printed information describing each loan and a list of documents to submit with the application.
While you are there, you may also inquire about the following:
- Is there a prepayment penalty on any of the loans?
- Will I have to pay a fee if I pay off the mortgage before the end of its term? (Important if you refinance when rates go down, or if you might move.)
- Do you have preferred customer benefits?
- Do you offer lower rates if I use other services you offer? Are other services offered at a lower cost to borrowers?
- How long will a mortgage decision take after application has been made?