Breaking The Log Home Financing Mythes
Kevin J. Daum

This article was originally published in a 2008 edition of Log Homes Illustrated magazine.

Financing custom log homes can be a confusing process.  Since there is little standardization for the custom home process much misinformation has spread through custom home circles. The problem is that a custom home process is just that…custom!  No one does it the exact same way twice and everyone’s situation is different.  Since few loan officers specialize in land and construction financing, very little is documented about the process.  People relate their own experiences which may or may not apply to your specific needs.

Well have no fear!  I have compiled a list of common myths I hear on a regular basis along with actual facts so that you don’t fall into common traps that could cost you money or even your project.

Myth: I have to pay off my lot before I get a construction loan.

Absolutely not!  In fact it is not even a good idea.  You will need a ton of cash to get through a construction project and every dollar you put into your land will be lost.  You need money for designs and deposits not to mention permits and fees.  Many people pay off their land and then have nothing left to build or qualify for a construction loan.

Today there are fantastic programs available for borrowing on a lot.  You can borrow money for anywhere from 5 to 20 years and at reasonable fixed and adjustable rates that are only a little higher than home loan rates.  Some lenders will loan you as much as 90% of the purchase price and with excellent credit you may not have to show any tax returns.  Remember, cash is king so don’t give it up until absolutely required.

Myth: I should get my lot, plans and builder before I start worrying about the construction financing.

How can you determine what and if you should build without understanding the financial impact?! Unless you are going to build your project completely from your own savings, you will rely on funds from a lending institution. These lenders live by “The Golden Rule:” Them that has the gold makes the rules! Many consumers plan their whole project before consulting a construction lender. They invest years of time and thousands of dollars, only to discover they made vital mistakes along the way, restricting the financing of their project or stopping it altogether. Time is an ally in building a Log home.  Start early on the education process by talking to a construction loan expert so you can get your ducks in a row and avoid unnecessary mistakes.

Myth: I should buy my lot, and then decide what to build.

One of the major factors in lender guidelines relates to the appraisal of the finished property. The lender evaluates the property for market value and conformity with houses in the neighborhood. In order to determine fair value for a lot, you need to make sure that your Log home is consistent in size and quality with houses in the neighborhood. Overbuilding or underbuilding for a neighborhood can cost you cash and equity. The fair value for a lot can only be determined within the context of a finished home. Many borrowers have purchased lots for what they thought was a great price, only to find out that the home they wanted will require significantly more cash than they have available.

Work with a loan officer or real estate agent to research a neighborhood and determine the potential appraised value and optimal building size and amenities. Then you can design the house to fit the optimum value.

Myth:My house will be worth what it cost me to build it.

Most people have never experienced the home building process. There are more than 100 different checks to be written for various products and services before you move in. Many of these expenses are hidden or sneak up on you during the process causing projects to go over budget more than 25% of the time. No lending institution will judge the value of the property based solely on how much money you put into your project. They will account for the money that you have contributed, but the weight of their lending decision will be made on the appraised market value. You will only know the true value of a home when it is sold.

Myth: Log Homes are hard to finance.

Log homes can be a little more difficult then stick built homes but only because there are fewer lenders that will lend on them.   More and more however national institutions are funding purchase, refinance and construction mortgages on Log Homes. 

The biggest challenge with getting loans on Log Homes has to do with appraisals.  Many lenders require information on comparable log homes that have recently sold in the area.  Since few log home people sell their homes there are not as many comps available.  The other challenge is that log home consumers often over or under build for their area creating value issues on the appraisal.

Myth: I can start with a small construction loan at the beginning and just finish the project out of savings as I go. I should borrow as little money as I can get away with.

There are many factors to consider when determining the right loan amount. Many people consider their home loan separately from the rest of their finances. A Log home is likely to be your biggest single asset, your biggest single liability and your best resource for tax deduction. The loan payment will either insure or disrupt your ability to sleep at night. The size of your permanent loan should be determined within the context of your entire financial picture.

While the permanent loan size is a factor in financing your Log home, it is less important than the financial structure of the build itself. Between savings and the loan, you must have enough money to cover the entire cost of the project plus any overages. The lender will require that all of this money is accounted for on the day you start the construction loan.

When choosing the size of your construction loan, Borrow as much as you possibly can!  Running out of money during a construction project is the number one, absolute worst thing that can happen.  Many things can happen along the way that may change your cash needs for your custom home.  If you run out of money, you can expect to pay high fees for additional cash, if it’s available at all. If no financial solution can be found, your project will fall to foreclosure.  Despite extensive estimates, there is no way to know for sure how much your construction project will cost until it is finished. 

Myth: Construction loans are just like any other home loan. The best loan has the cheapest rate and fee.

When you purchase or refinance a home the process is over when the loan funds. With a construction loan it is only the beginning. The success of your project will depend on how well the 6 – 12 month disbursement procedures are compatible with your finances and your builder’s style.  The variables in qualifying for a construction loan are ten times that of purchases and refinances. For example, you may choose a loan that has a lower rate, but because of the “Loan to Cost” requirement it may cost you $100,000 in savings.

Lack of borrower information and poor packaging by brokers are the reasons that most construction lenders deny more than 40% of construction loan requests. Many lenders and brokers merely dabble in construction    The best have become specialists in construction financing and have financed hundreds of successful Log home projects every year. They can integrate of loan programs with your financial needs and the needs of your builder.  Find an expert loan officer who can account for rate, fee, qualification, builder methods, cash flow, timing and many other factors. You want to be educated as to your choices at every step.

Myth: I have to sell my home and rent before I can start building my new home.

Many construction lenders today don’t consider your existing home in qualifying for your new home. This coupled with low rate refinances and credit lines for accessing liquidity means you will only have to experience the inconvenience of moving when your Log home is complete.

Myth: The land and construction loan qualifying process is arbitrary.

The banks are essentially looking for two things.  First they want to know that the home will be sufficient collateral to secure the money they are loaning.  This means they want to make sure the house will be built within the budget and will be a marketable house when it is finished.  Red flags for banks on construction loans are things like budgeting too low; over or under building for the neighborhood or building something that only you would ever want to live in.  They will set a limit on how much they will loan you based on both the appraised value as well as the total budget for the house. 

The second assessment for the bank is your ability to repay the loan.  When the banks evaluate you they look at three basic areas, credit, liquidity and income.  Today credit scoring plays a huge part in loan underwriting.  If you don’t meet the required credit scores you won’t have much else to talk about.  Check your score early.  There are ways to work with your loan officer to increase it by clearing bad marks and reducing credit card debt.

Next the bank will look at liquidity and it is just as critical as credit.  The banks are not as concerned about the money you already spent as they are about the money in your bank account.  They want to see enough cash to fund the project along the way as well as money for reserves since these projects are unpredictable.  There is no flexibility here.  Even if your credit and property look great you will have to meet the cash requirements to the penny to qualify.

The last piece of the puzzle is income.  Banks like to see your total house payment and monthly debts equal roughly 40% - 45% of your gross monthly income.  However if you meet the credit and liquidity requirements you may not have to deal with the income issues at all.  No Income Verification (NIV) loans can be useful for self-employed people who write down a lot of their income for tax purposes.  They can cost a little more but it’s worth it if you can’t qualify with documentation.  A good mortgage broker can guide you through this process.

Hopefully you now have a basis for meaningful conversations with lending institutions.  This is your home however so educate yourself as much as possible and don’t be timid when talking to loan officers.  Ask the hard questions and make them get the answers.  Also, don’t take the answers you get at face value.  There is no shortage of loan officers who will make up answers just to get rid of you especially if they think you are high maintenance.  Others will give you half correct answers out of pure ignorance.  The best approach is to ask every question three times or until the answers become consistent. 

About the Author...
Kevin Daum is the Founder and CEO of Stratford Financial Services, a Real Estate finance and education company, founded in 1989. Stratford specializes in Purchase loans, Refinance loans and Custom Home Construction finance and has successfully financed thousands of clients. He is the author of "Building Your Own Home for Dummies" (Wiley), as well as "What the Banks Won’t Tell You." Mr. Daum was an Underwriter for Plaza Savings and Loan and Key Bank of New York. He is an INC 500 CEO and has been listed as one the 40 Most Influential People Under 40 in the San Francisco Bay Area. He is the Global Chair for the Edison Innovation Program with the Young Entrepreneurs' Organization (YEO) and is a founding Board member of the Bay Area Chapter of YEO.

Mr. Daum is a frequent contributor to numerous business publications on the subjects of Real Estate and Small Business leadership and speaks regularly on both subjects. He can be contacted at kevin@stratfordfinancial.com.