pocket where you need it most.
Getting denied: What the banks won’t finance
We can think of several situations that will eliminate conventional financing as an option to buy a lot. Some are based upon your own situation and some on the property. Here’s a quick checklist:
If your credit score is below 640 (see Chapter 10)
If you’ve been late on your mortgage in the last 12 months
If you’re unemployed
If you have no down payment
If the property has existing buildings on it
If the property is more than 50 acres (some banks allow only 20 acres)
If the property has no electricity nearby
If the property has no public access
If the property has multiple parcels (some banks allow two)
If your property or qualifications fall into one of these categories, don’t panic just yet. Other lending alternatives are available. Some may cost more money and be more restrictive than conventional lending, but they may be better than the thought of abandoning your project.
Finding other land loan alternatives
If you find the perfect lot and the bank thinks the property or your credit and income are less than perfect, you still may be able to buy it without paying all cash. Some lending alternatives are available if your property or credit doesn’t meet the bank’s guidelines.
Letting the owner carry the burden
One alternative way to finance a property is to have the property owner loan you the money or carryback paper. In this case, the seller acts as the lender and has you (the buyer) execute a note secured by the property for the amount he doesn’t receive in cash through escrow. Not every owner will consider this option. If the owner carries back the entire amount of the purchase price, the seller can’t owe any money on the property. Another way a seller can help is to carry back a second loan so that you can put down a smaller down payment. The primary lender must agree to this arrangement. In either case, the seller has the ability to foreclose if you miss payments. You need your real-estate agent or an attorney to draft the note and security instrument to make sure everyone is properly protected.
When is a seller more willing to carry the financing themselves? A seller may agree to carry paper if the property is hard to finance through banks or if they — for whatever reason — are anxious to sell. The seller may also want to defer the taxes due from the sale of the property; carrying paper allows the seller to pay taxes only as you pay off the loan. You gain no real advantage when the seller carries the financing unless the loan’s terms are more favorable than any other lender offers you. Most construction lenders require the seller to be paid off when they fund the construction loan. Few institutional construction lenders allow a subordination of a seller carry.
Using private or hard money
Hard money comes from private investors who specialize in making loans on real estate. Hard-money lenders generally aren’t concerned with credit or income. They hope to make high-interest yields or make money by taking back your property through foreclosure and selling it at a profit. Typical hard money runs a number of percentage points higher interest than the prevailing market rate, plus 5 percent of the loan amount in upfront fees, called points. This high interest seems expensive, but if banks or owners won’t give you a loan, then this choice may be better than not buying the lot at all. Because hard-money lenders like equity, they usually want as much as a 50 percent down payment.
Making sure the loan period is long enough
Lot loans come in a variety of lengths, but few lenders offer them for more than five years. Your lot loan needs to be in place until the construction loan pays it off. Most projects can make it to the construction-loan phase within two to three years. If you think you’re going to take a long time to design your home or that you’ll need to save your money for a long time before beginning construction, then you may want to search for loans that last more than ten years.
How long it takes to begin the building process can vary wildly. The ultimate amount of time is based upon your local planning departments, how picky you are with your plans, how busy the current construction climate is, and many other factors. Figure out how long you think it will take and double it to be safe. Most of the delay factors will be beyond your control.
Stop! Don’t pay off your lot yet!
Contractors, consumers, architects, and many others often tell you that you must pay off your lot before you get a construction loan. This is the biggest myth in the custom-home-construction world. Actually paying off the lot isn’t a good idea unless it’s absolutely necessary. The following sections explain several good reasons to keep a loan on your land until you’re ready to build.
You need cash on hand to fund your project
Buying your land is just the beginning of paying people in a construction project. The architect, the engineer, the well and septic people — and many others — all need to be paid along the way. The permitting process can suck your cash as well. These people and processes can add up to tens of thousands of dollars. If you run out of money because you put all your hard-earned savings into your land, finishing the build on your new home can become a nightmare. Having cash in your pocket is your best protection for keeping your project moving along. Check out Chapter 8 for more on this subject.
Money put in is expensive to get out
Few lenders have refinance programs for land loans. And in most of those cases, they only let you replace an existing loan. Rarely does a lender give you a refinance loan where you’re taking cash out of a piece of land. That means that after you put money into the land, it’s gone forever — at least until your construction loan has started. Your only choice will probably be hard or private money, which can cost 5 percent of the loan up front and 10 percent annually. This increase compared to institutional lot loan pricing is an expensive price to pay for money you already had in your pocket to begin with.
Cash reserves are required for construction
