Tuesday, May 16, 2017

Construction Loan Woes

So, in my first blog about building a house, I talked a little about the differences between home loans, land only loans, and construction loans.. and now I have experience with all three. Mind you, I'm definitely not an expert, so I'd recommend contacting a loan officer that is proficient in construction loans if that's what you're working towards.

With the conventional loan, it was a little stressful as we had a high deb-to-income ratio (DTI) back then. We were still paying off debt, and Graham was only working part-time at the group home for $10/hr. We recently had switched one of our credit card balances to a 0% APR, which then lowered our monthly payment, so then we qualified for the loan. That was a big relief.

The land-only loan was scary because we were completely out of our comfort zone. We had to contact the county about land planning, ask a geologist about soil tests, and learn about balloon payments on loans.. It was more work than we were expecting.

And then, we went through with the construction loan.. Honestly, if I could have done it all over again, I would've done the all-in-one construction loan, with the land rolled in with the construction costs. It would've been so much easier to do it all at once, and it would've saved us a few thousand dollars in closing costs. However, we weren't ready to sell our house last fall/winter, which was necessary for a good portion of the down payment on the loan. Plus, it would've been a crazy amount of work to get everything we needed for the construction loan.

So, here's the low-down on a construction loan. There are several terms you'll need to get familiar with: DTI, closing costs, and the loan-to-value (LTV). Your DTI is fairly simple: your average payments on debt compared to your average gross income. To be approved for a mortgage, the recommended DTI is usually at or below 42% (including rent/mortgage). Closing costs can be several thousands of dollars, depending on your lender. They usually include loan origination fees, appraisal, and all kinds of fees (title, county, escrow, etc).The LTV is a little more complicated for a construction loan. If you put zero percent down on a house, the LTV is 100%. Unless you do a specialty loan (such as the USDA loan that we did or a VA loan), many lenders won't do 100%.  Also, you have to pay Private Mortgage Insurance (PMI) if the loan is >80% LTV.. which can add $200+ per month to your mortgage.

The complicating factor with a construction loan is that some lenders allow you to only put 5% down on a construction loan.. which is great for people like us who have cash but don't have like $80K to put down on a construction loan. Many banks require 20-30% down on construction loans due to the higher risk of new construction. Anyways, we based our future mortgage payments on our home's estimated LTV after appraisal.. For example, if it cost ~$400K to build a home, and the appraised finished home value is $480K, the LTV would be 80% and we wouldn't have to pay PMI. What we didn't account for initially was the LTV on the construction loan (~90-95%).. so we have to pay PMI on the construction loan.. which initially increased our estimated DTI. So, we have to pay PMI on the construction loan while the home is being built. We can re-finance the loan after the home is finished so we won't have to pay PMI, based on the fact that our home will be appraised way higher than what we will have paid for it. This is definitely a bonus to a buyer's market.. as most homes in our area are being sold for $180-200 per sq foot.. so our home could potentially be worth $455-505K after it's built.. which is way more than what we will pay for it.

Going through this process has been anxiety-ridden, as we've felt like we didn't have good communication from our lender, and our questions weren't always answered in a timely fashion. We also had to get bids for all of the items not provided by our home builder, such as the outdoor concrete for patios and driveways, site development, septic design and install, utilities installation, electrician fees, permits, on-site portable toilet.. etc etc etc. It was quite the project, but I managed to do all of it fairly quickly. If you know me well, you'd know I hate making phone calls, so I hated every minute of talking to strangers about things I only have a vague knowledge about. I've never felt so stupid in my life asking an electrician about how we get temporary power to the house.

Due to the poor communication from our lender, we even contacted another loan officer in our area (Terry Pemberton of Umpqua Bank) to see if we could get a better deal basically. He was very knowledgeable and quick to respond, so I'd highly recommend him if you're building in Washington state. However, our current lender had the best product for us, so we stayed with them. We should be closing soon.. but right now we are waiting for the appraisal. I'm really quite curious as to how the appraisal will turn out, as it's just based on the plans, the HERS score (that's a discussion for another day), and the upgrades we're planning on putting into the home. Let's hope it comes out high!

Stay tuned for my next home building blog.. I'm planning on blogging about the design and pre-permitting process. Should be fascinating. I'm sure.




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