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Kevin J. Daum
This article was originally published in the July 2004
edition of Log Homes Illustrated magazine.
I just spent three fabulous days at the Log Home Expo in
Sacramento and another three days at the one in Las Vegas.
I hadn’t been to a Log show in a couple of years even
though my company has been financing log homes steadily since
1996. It was great to see the increased enthusiasm among prospective
Log Home owners at this show. The thing I love about Log Home
people is that they are more meticulous about studying information
regarding their home building materials than any other custom
home building consumer.
In the stick-building world, one rarely overhears Mr. Jones
talking with his soon to be neighbor Mr. Smith about the Paralam
they installed in his new home. Somehow the Oriented Strand
Board and Ring Shank Nails never make it to the dinner table
conversation. Stick built people for the most part are happy
to let their contractors select the basic materials and wait
to focus on all the pretty finish stuff instead.
Log Home people however, will spend countless hours perusing
every publication and manual learning about chinking and the
right kind of bolts, whether springs help expansion, white
cedar versus red cedar, handcrafted versus milled, air dried
versus kiln dried and so on and so on. There was no shortage
of detailed education to be had at the show that was for sure.
The thing that fascinated me the most about the Log shows
(aside from the cooking demonstrations, I have been eating
healthier ever since), was the huge amount of misinformation
that was traveling around regarding financing. It was as if
Hans Christian Anderson himself had learned about log home
financing and had come to spin yarns. And the amazing thing
was how willing the Log Home people were to believe the lies
and myths and stories that were being told to them.
In the last ten years there have been numerous new lenders
for financing land and construction and yet these intelligent,
investigative Log Home consumers were unwilling to go beyond
their own nose to check out the truths about financing. I
was astonished as I listened to consumers and even heard speakers
at seminars declaring financing fables that would rival the
brothers Grimm. Client after client would parade to my booth
and tell me they were waiting to build until they had accomplished
the biggest single mistake you can make in financing a custom
home…they were trying to pay off their lot!!!!
Everyone was anxious to take their hard earned cash and continuously
force-feed it into paying off their land. Even the people
who hadn’t bought land yet were thinking that they had
to wait until they could muster up enough cash to pay off
a piece of land completely. Otherwise they believed their
Log Home dream would never become reality.
“Who told you this was a good idea?” I kept asking.
The answers were amazing! “ My friend said that it was
necessary,” said one. “I heard it somewhere,”
said another. “That’s what the local bank says…The
Dealer says…My wife’s 12-year-old cousin in Schenectady
says…” etc., etc., etc. Even articles in competitor’s
magazines have been propagating this myth in recent times
despite the research they must be doing.
So let’s clear up this myth once and for all. I am
telling you as a 21-year veteran of the Real Estate and Finance
industries and as someone who has successfully funded hundreds
of Dream Home projects, YOU DO NOT HAVE TO PAY OFF YOUR LOT
TO GET A CONSTRUCTION LOAN!!! Actually it is not even a good
idea to pay it off unless it is absolutely necessary! I understand
that we all come from depression era parents and grandparents
that instilled in us the adage of “Pay off your real
estate.” But remember, this was the same generation
that believed cigarettes were good for you and coffee was
great for relaxing! Sorry Grandma, I know you meant well.
So here are four good reasons to keep a loan on your land
until your construction loan is in place.
1. You need money to advance your project.
Buying your land is just the beginning of purchasing and paying
people in a construction project. Before you get any where
near a construction loan you are going to have to pay for
your deposit on your Log Package. You will also have to pay
to get through the permitting process. You may have to pay
for engineering, well certification, septic certification,
bringing power to the site and a bunch of other costs too
numerous to mention. All of these can add up to tens of thousands
of dollars. If you run out of money because you put all your
savings into your land your project will come to a screeching
halt. Even after you get your construction loan you will need
cash to run the project while waiting for reimbursement from
the bank. Liquidity is the number one insurance policy for
keeping a dream home project going.
2. The banks want to see lots of cash for construction loans.
Cash reserves are a critical part of the bank approval requirements.
The lenders want to see that you have enough savings after
you start the project to solve any problems that might arise.
The amount of required reserves varies from bank to bank and
they don’t always tell you up front how much they are
looking for. In addition, the amount of money you need to
have into the project won’t be determined until roughly
60 days before you start building. If you are short on the
banks cash requirements they will not take into consideration
how much money you have put in the project so far. The banks
truly don’t care whether your land is paid off or not.
3. Once you put money into your land you cannot get money
out cheaply. There are many loan programs for purchasing land,
which I will talk about later in this article. Unfortunately
there are hardly any programs for refinancing land and almost
none for taking cash out. That means that once you put money
into the land it is gone forever, at least until your construction
loan has started. Even then most bank construction loans do
not allow Land Draws for taking some of that money back. Since
you won’t know how much cash you will need for the project
until it is completely finished, it is best to keep your cash
as liquid as possible until the end of your project. If you
run out you may be forced to pay a premium for private money,
which I explain below.
4. Tax deduction
There are few good tax deductions left in this country, and
happily interest on real estate is one of them. Even though
you are not yet living in the property, the interest and loan
points that you pay on a land loan should be deductible providing
that you finish the house and occupy it as your primary or
second home someday. That means the government will assist
you up to 40% to keep your cash in your pocket. Depending
on your income the interest could even be enough to put you
into a lower tax bracket. This is a great conversation to
have with your CPA or tax preparer. You can opt out on this
one if you already feel you are getting your money’s
worth from the government and you feel like paying more than
your share.
The more cash and tax deduction you have available the smoother
your project will run and the happier you will be. If you
have already paid off your land there is not much you can
do about it now but continue to hoard your cash. If you own
land but haven’t paid off your loan yet STOP!!! Keep
your cash in your pocket where it will do you the most good.
For those of you who have not bought your land yet, you are
in luck. There are great new land financing programs available
today that never before existed. Did you know that you could
finance a piece of land for up to 25 years? Even the slowest
of the slow can get their building project underway in that
amount of time.
It is easier than ever to put down small down payments and
qualify for purchasing land. Even though most local banks
still want to see all your financial information and are looking
for large down payments of 35% to 50% of the purchase price,
large institutional lenders like Washington Mutual and IndyMac
Bank, the 16th largest bank in the country, have come out
with No Income Qualifying loans. With good credit from these
national institutions you can buy land with as little as 15%
down without having to show a tax return. If you can show
that you make enough money to qualify, you can buy land with
as little as 10% down today. You can contact these banks directly
or most of these programs are available through any mortgage
broker experienced in land and construction financing.
In fact it is a good idea to work with a trustworthy, knowledgeable
Loan Officer that can educate you as to which programs are
best for you. While these land programs can seem simple at
a glance, these banks finance construction for many log homes
and your information needs to be presented for the Lot Loan
and the Construction Loan in a consistent manner. If your
information is not presented to the bank correctly, you could
have difficulty getting your construction financing. Make
sure you discuss these issues with your Loan Officer before
you start handing them all of your financials.
Another important thing to mention is that these institutional
lot programs don’t work for all properties. You may
still have difficulty finding loans for raw land over 40 acres
and for remote properties that have no access to the electrical
grid. The banks are comfortable with other alternative utilities
however, such as wells, septic systems and propane gas. They
don’t usually require these to be installed before you
finance the lot and they are happy to help you finance installation
of those utilities with the construction loan.
There are lending alternatives if your property or credit
does not meet the bank guidelines. For those of you still
looking to purchase land you might ask the seller to finance.
It can be beneficial for them since they only pay taxes on
the money they receive from you. Giving you a loan can spread
out their tax liability over time. Other options for purchase
or refinance money may be private or “hard-money”
lending. This is money provided by private investors for short
periods of time such as one or two years. Typical hard-money
today costs about 10% interest plus 4-5% of the loan amount
in up front fees called points. This is about twice what the
banks charge for a conventional land loan. These hard-money
loans are considered more expensive but expense is relative.
If the banks won’t give you a loan and these are the
only people that will then they are not so expensive after
all. Hard-money lenders do tend to restrict their lending
to about 60% of the purchase price so you will need to have
more money for a down payment. Hard-money is one of the few
options for taking cash out of your land.
As you can see there is no shortage of options for keeping
your cash available from day one of your Dream Home project.
Having a Lot Loan will make qualification easier and make
your project run smoother. It does not mean you will definitely
have a big mortgage payment when you finish the house. You
can still decide to pay off the mortgage when it is all finished.
That is not in your best interest either but we can save that
myth for another column.
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.
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