tell me about construction loans and DP.

8 years ago

We have the lot....it should appraise for 25k possibly more....... the home we are hoping to build is roughly 2400 sq ft including the finished bonus room w/2 car attached and 2 car detached garage. Cost to build is roughly 240-250k. How will our land play into all this as far as "equity" when we look for a loan? Similar homes in the neighborhood would sell for 275k with a tax value of 260k.... if that matters. Just wondering how much of a DP we will need. I have heard we could possibly use our land as equity and not have to actually have 20% cash DP???

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amberm145

8 years ago

The question is how does the land value get used as a downpayment. You've said that houses in the neighbourhood are selling for $275k, so we'll assume that's what your house will be worth, for the sake of explanation. With any mortgage, building or buying, the bank wants to know that they'll be able to sell the house (and land together, obviously) for at least as much as you owe on it, in the event you don't pay your mortgage. So to protect themselves, they may say that the max they'll loan you to build or buy the house is 80% of what it's worth. So $220k is the maximum amount they are willing to put into that house. And that includes the land.

If you were buying one of the existing houses, your downpayment would be the $55k needed on top of the $220k to pay the $275k for the house. And the idea is that you've got an incentive to keep paying your mortgage in order to not lose that $55k.

Let's say for the sake of the explanation, your land was worth $100k, and it cost $220k to build the house. The house may still only be worth $275k. It doesn't matter to future buyers that the land and build cost was $320k, if they can get another similar house for $275k, that's all they're going to pay. And that would be all the house is worth. And this happens because custom costs more. You pay a premium for getting "exactly" what you want.

So, assuming you own the land outright, you need another $220k to build. So you borrow that from the bank. The land becomes your "downpayment" because it's what you'll lose if the bank has to foreclose. If you didn't already own the land outright, and needed a loan to cover that, you can get the loan for $100k, and then borrow another $120k to build the house, and then have to come up with $100k towards the building cost. So while in the first example, you feel like you're getting the shaft, having to borrow the whole amount even though you own a $100k piece of property, it is still saving you having to come up with the extra $100k for the build. Or, if you had $25k equity on the land, you could borrow $145k towards your $220k build, and then only have to come up with $75k in cash.

Other than putting up the value of the land against the risk of default, for a small amount of land value against the cost of a build, you don't really get to use the land as a "downpayment".

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Comments (7)

User
8 years ago
last modified: 8 years ago
Appraising as a "Lot" and as land under a built home is an entirely different valuation. You don't get to add the Lot value to the construction cost to determine a whole value. It doesn't work like that. In a lot of cases, building on a property reduces it's value as land. There is no circumstance of any home build that you won't NEED at least 20% down. If your bank requires less, you will end up needing it as a contingency. Especially in case it won't make appraisal at completion. Remember that most homes appraise for less than they cost to build, and that shortfall has to come out of your pocket. Cost to build has nothing to do with value as built.
whaas_5a
8 years ago
There is no circumstance of any home build that you won't NEED at least 20% down.

I don't think that can be said as a blanket statement. It depends on your ratios, credit score, bank, market, etc. You can get a construction loan for 10% down. You just need to be willing to pay PMI. At that point would you need a 10% contingency, I don't know...I guess do the proper lot improvement research, limit allowances and lock down your plan. Then have the conversation with your bank. And be sure that person is well versed and experienced with new construction.

Your lot loan will wrap into your construction loan but as Sophie said it gets reappraised.
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MrsGordo is right on. I just got through going through that process. From my experience, hardly anyone does any 1-time construction permanent loans anymore. I called around to about 8-9 local banks and a few internet based mortgage companies and all of the internet based places said, "We don't do one-time close, your best bet is a local bank." Well, all of the local banks said they don't do that anymore. So, I had to go with a separate interim construction loan, at that point...its just shopping the different rates/closing costs. It varied so much. Some banks charge a point, but if you use them for permanent they credit that back to you. Some of them told me flat out, if they can't get the permanent they don't want to mess with the interim (Since they don't make very much off the interim). The bank I wound up using was referred to me by my builder. He uses them, and has referred other clients to them and never has heard anything negative. I wound up going with that bank, and it really worked out well for me. They had the best rate, no points (which allows me the option of shopping the permanent), and also they have a relationship with my builder already. So he knows what they need, and they know he does quality work and finishes on time and in budget. My interim construction loan also encompassed the purchase of the lot. So based upon my total loan amount, the amount I put down paid off the lot and put some in the balance of our building account. Now, if we can just get some DRY WEATHER Q#$(#$@#$!!, we can actually start and i'll start making draws and paying the interest. So, i'm not sure how it'll work with you buying the lot so far in advance of building. I would call around to some local banks and get some ideas from them. Make lots of notes on who you talked to, the rate, any points charged, application fees, etc so you can look back on the big picture and see who has the best overall terms for your situation.
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I am sorry for your trouble. I am from a rural area and what live_wire_oak says is true--discounted sales are comps. In my rural area, high end houses are always worth less than they cost to build because there aren't many people that can afford to buy a high end house and those that can build their own. When the people who build these high end houses leave, the houses are sold at what you may think is a very discounted prices but which is really the FMV in a rural economy, even when the economy is good. Banks, especially now, have to look at market value in the area, not cost, when making their loans. I can feel your pain because you should have been told this at the beginning, not the end. You need to appeal the appraisal, but you are correct that it will be difficult because appraisers have taken a lot of the blame for the current mortgage crisis and are now being more careful than they used to be. I would also investigate whether you have any type of claim against the original appraiser--your reliance on his appraisal has harmed you.
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I am guessing there are different types of loans and different processes out there. We are just getting started on our build, but my lender said that 45 days prior to occupancy permit we can lock in a lower rate if one is available to refi the construction loan to a conventional (construction loan rates, for us, were about .5% higher than prime conventional rates). If lower rates are not available and we do not want to refi, our construction loan is interest only for 12 months then automatically converts to a conventional at the same rate. Our lender allows the same appraisal of land + project to be used if we want to refi the loan. If you can get a better rate with a refinance, simply calculate the yearly savings in interest vs your closing costs to refi the loan to find out a "break even" analysis - how many years will it take for you to break even on closing costs vs interest savings. If it makes sense, do it...interest rates likely will not be going anywhere but up in the next few years.
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greg_2015
8 years ago
In general, it depends on what your house AND land (as a single unit) will be appraised for after the build. The bank will loan you 80% of THAT value.

For example, if the appraisal will be 275k, then the bank will loan you 220k. (80% of 275k)

If the cost to build is 250k then you need to come up with the extra 30k.
whaas_5a
8 years ago
But the bank may not require 80%. You will need that though to avoid PMI
Rachel (Zone 7A + wind)
8 years ago
Our build loan was 10% down but we needed to have the contingency in cash (3.5%) AND be able to refinance by bringing the other 10% down against final appraised value at the end of construction.

If we had NOT had the other 10% down, on appraised value, we'd be stuck in the construction ARM at 4.125% rather than securing a fixed rate mortgage.
Rachel (Zone 7A + wind)
8 years ago
You can get a HELOC if the house appraises to avoid MI up to 90% LTV with the main loan.

tell me about construction loans and DP.

amberm145

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