Totally confused with land and construction loans....

jmjmommyAugust 5, 2008

Hello! I have spent the day trying to get info on our future loan. We are in contract on the lot but will wait until our current house sells before construction begins. Hopefully that will be soon! Anyway, I know financial matters are private and personal, but I was wondering if you can share your tips and thoughts with me. Did you do a land loan with the same place you are doing the construction loan? Once our house sells we could pay the lot loan off completely. We like one company for the lot loan, but I don't like how they do construction loans. My head is spinning and I know we need to get the ball rolling on the lot loan.



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I am sure someone here will have some better advice for you.... I think you could certainly use two different lenders for the two different loans. Your very best position though would be to buy/payoff the land loan completely before even applying for the construction loan. I know when we financed our big bonus was already owning the land- lots of equity. It made the whole transaction more appealing to lenders.

Good Luck.... exciting and scary all at the same time!


    Bookmark   August 5, 2008 at 5:35PM
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We purchased our land several years ahead of when we knew we would be ready to build on it. One thing that surprised us was finding out that "land only" loan interest rates are significantly HIGHER than construction loan rates or regular mortgage loan rates.

When we bought our land, mortgage loan rates had pretty much bottomed out in the low 4% range and, even though we have excellent credit, the best land-only loan quote we could get was for like 7.7% That blew my mind. Heck, at that time even new car loan rates were running around 6.2% and it made absolutely no sense to me that a bank would be wiling to loan my $50K to buy a fancy new car - which I could wreck the day I drove it off the lot leavingthem with absolutely no collateral - at a cheaper rate than they wanted to charge for loaning me the same $50K to buy 4 acres of residential property in a very nice upscale gated community. I mean, I always thought interest rates were reasonably tied to the amount of risk the lender was taking and it wasn't like the land was going to GO anywhere if I failed to make payments. And, while its value might fluctuate slightly with the market, the land was NOT going to depreciate 50% the minute I signed the paperwork like new cars pretty much do! So go figure...

Anyway, long story short, we decided to refinance our current (almost-paid for) home and use the cash to purchase our land. Actually wound up getting a better interest rate on our mortgage than we had had so, even after paying refinance charges, we basically borrowed the money that was used to buy the land for free.

Not sure you'll be able to swing quite as good a deal these days but, if you have quite a bit of equity in your current home and home equity loan rates are less than land-only loan rates, you might consider it. Then, when you sell your home, you pay off the your home equity loan completely instead of paying off the land loan. Only difference is you get a loan at a lower interest rate.

    Bookmark   August 5, 2008 at 6:21PM
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Hope this helps...Just like the land loan, construction/home loans require a larger downpayment than typical home loans. You have two choices in construction/homme loans..."one time closing" and two seperate loans, i.e. a construction loan then refinancing to the home loan. You don't have to go with the same company if you use the 2nd choice (note one time closings only have one time closing costs, offer the ability to lock interest rates at time of bldg and if anything happens to your credit while bldg you've already closed on the home loan). There is no need to pay off your land..your land will roll into your home loan whether its paid off or not. The real questions is how you are going to pay the down payment on the loans. You can either pay your downpayment with the equity you have in your land (due to being paid off or due to improvements) or with cash. In our case we purchased the land (on a land loan), then preferred to use our cash to upgrade by adding the construction drive, septic, fencing and large metal building (barn). That increased our value triple over our orig land costs. That will now become our downpayment. Its better to use the cash you have to increase the value of your land than to hand over in a downpayment. Of course if you have a "lot" instead of acreage it will be hard to improve it enough to create the equity so paying it off would be no different then paying the cash as a downpayment. I personally prefer the one time closing option as I see no reason to pay double closing costs and financiers are concerned with how high home rates will go and it offers us the option to lock down the interest rate.

    Bookmark   August 5, 2008 at 6:41PM
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We bought our land first, almost no money down with a high floating rate, heck we just needed to finalize with our builder and selling our house was closing days later. So we float big interest for a month or two and start the construction loan... one full year later, we closed on the construction loan. It was our 5th mortgage with Bank of America, so our loan guy got us a decent rate on our jumbo, but since then he said they wouldn't even do our loan now. We put 20% down, credit score over 800, and no debt.

We decided that we'd look better financially coming to close on the construction loan with cash instead of land equity, that's why we did the no money down loan on the land.

    Bookmark   August 6, 2008 at 7:15AM
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bevangel ~ re risk-taking: the mortgage on the land is usually supported only by the land itself and if it defaults, it's totally repay-dependent on potential resale value. The "mortgage" [loan] on the car is offset by the availability of insurance which will repay the loan, regardless of the actual condition of the car. Thus there is far less risk to loan money for the purchase of a car than there is for the purchase of land. There is a general mortgage insurance available, however, I haven't noticed it being used for land sales. otoh, I've never looked into that particular area.

OP ~ Like others here, I think that if you want the most value for your dollar, buy the land first. When you are within 2 years of paying it off, start planning the house.

    Bookmark   August 6, 2008 at 7:48AM
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When you say "We are in contract on the lot" - with whom? Is it an independent seller of the land or with a builder? if with a builder - what type (custom home builder or large residential builder like Toll Brothers)?

These answers are needed to better help you out. If you put a contract on a lot with an independent seller of the land - then don't do a seperate land & construction loan. Simply wait until your current house sells and buy the land with that money. I will explain why in a minute.

If you are buying through a custom builder who owns the lot, then don't do a land loan either.

If you are buying through a large residential builder, the land and house are bundled together in the purchase price and the mortgage loan you get will cover both land & house. Only 1 loan is needed - and you don't close on that loan until the house is done.

Getting a loan on bare land with no house on it is expensive (higher interest rates and harder to qualify ) because it is a bigger risk to a bank. It is usually harder to sell bare land than one with a house it (exceptions to this rule are in places like Malibu, CA). Why pay points, loan origination fees, and closing costs on a seperate land loan that you can purchase with cash?

Typically when you apply for a construction loan, the land value is included as part of the estimated value of the house/land when it is complete. This is important because that total value will be used to calculate how much money you can borrow. Let's say your land is worth $50K (and you own it out right with no loan) and the house when complete is worth $350K (the appraised value) - then the total appraised value of the property when completed would be $400K. If you put 25% of your own money (the land value and your planned cash into the house is included) into the construction project, then the bank will let you borrow $300K for the house project assuming you qualify for that payment. Note that the appraised value of the house IS NOT the contract price for the new house.

The construction loan can be seperate from the mortage BUT I would not recommend you go that route. There are banks who offer construction loans that will convert into the mortgage when the house is done. You close once on the construction loan (pay points & loan origination fee + closing costs) at the start, then you convert at the end and pay no other CLOSING costs. BUT watch out for this, at the end when you convert you will have to pay up to 6 months of estimated future taxes & insurance to seed the escrow account for your new mortgage loan so you will need to bring money to the table when you convert at the end (these aren't CLOSING costs per se but it is money out of your pocket). But at least you only pay closing costs and loan orgination fees once instead of twice.

The way the construction loan works is basically like a line of credit. You only pay on the loan amount as you draw from the line of credit - and multiple draws occur as the house is built (5 to 7 draws are typical). These draws are tied to completed stages of the house like plans complete & permits approved, foundation complete, framing & roof complete, rough in plumbing/electrical/HVAC complete, drwall complete, painting complete, final finishes complete, etc. So during the construction process - your monthly payment on the construction loan will incrementally increase as draws are paid out to the builder. That is why I suggest that you use as much of your own cash to make the initial draw payments to the builder and then draw down on the construction loan as late in the process as you can. Reason is that you want to minimize your payments on the construction loan - which are essentuially just interest payments. If you are paying rent and construction loan costs at the same time you can see that minimizing the double payments for as long as you can make it easier on you financially.

Example. let's say that you own that 50K piece of land and you have another $150K in cash from the sale of the house. You decide that you want to keep $50K in your pocket (to cover any possible overages - a good idea) and the other $100K to be used on the new house, and you have the $300K loan ready to go (so you have up to 400K to cover building costs on a project that should cost let's say 300K). So you start the project - you use YOUR $100K of money to pay the builder for the first 2 or 3 draws and the bank money money to cover the rest (you can also do a mixed payment where you put in some of your own money and you use some of the the bank money to cover a particular draw). So you pay the first $100K and let's say the house winds up actually costing you $325K because of a few oopses and some upgrades you decided to make. At the end, you only used $225K of bank money and $100K of your money. You only paid interest on the portions of the $225K as you paid the builder. You don't pay interest on the other $75K that you did not draw from the bank. When you convert the construction loan to the mortgage, your new mortgage will be for $225K.

If you can use your money to cover the initial few payments to the builder you might not not have to make a constuction loan payment until 2 or 3 months into the build - and that is 2 or 3 months worth of payments that you keep in your pocket. In our build, we started the project in Sept 06 but did not make our first interest payment to the bank until late Spring 2007 which was nice because our house wasn't finished until Dec 2007 - 6 months late.

You could do 2 seperate loans - one for land and one for house - but hopefully you get the point that you don't have to do it this way and it would cost you a lot more money (in loan fees and monthly payments) to have 2 seperate loans.

I Hope this helps.

    Bookmark   August 6, 2008 at 9:04AM
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Thank you all SO much!!! The lot is owned by another couple who never got around to building, not a developer. We can choose our own builder and build whenever we want. The lot costs $80,000 and we don't have that in cash now, so we can't pay it off completely yet. We could once our current home sells, but then we won't have 20% left for the house. We have met with a builder and the house (including well, septic, driveway, etc) SHOULD be around $220,000. We have $35,000 now and will have around $70,000 more once our house sells.

Thanks again for your thoughts! I really appreciate it!

    Bookmark   August 6, 2008 at 12:50PM
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You have the 20%! If you buy the lot for 80 grand (and let's assume it is worth exactly 80) then guess what - your total house value would be 300K (assuming no appreciation in new house value - probably an OK assumption given the market right now). BUT the 80K is your equity in the project. 80 divided by 300K is 26%!!!! The land is part of your investment into the project.

The 20% down thing is for a mortgage. It is basically the bank saying that they want you to have a stake in the house before they will lend you any money for the mortgage. The land in your case will act as your "down payment" - it is your equity in the new home.

Now with that said - if you start with 105K and pay 80 for the land, you would have about 25K in cash left to cover any overuns on a 220K project. Typical overuns that I have read on this forum are in the 10 to 20% range. But some have kept it below 5%,a few zero. So your cash would leave you at the low end of typical - but still you are in the ball park to make it happen. If you work like mad to control costs, you can do your project.

So do yourself a favor. WAIT until you sell the house you are in now. THEN work the new project. But if you want to - you have the financial resources to do it.

    Bookmark   August 6, 2008 at 6:11PM
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