Building Your Custom Home For Dummies. Peter Economy

a deed to the land and a policy insuring that it’s yours. The title company pays the seller the money due and records any documents and deeds related to the transfer and new loan.

      Using the bank

Most people finance their lot purchase through a local bank or private lender. A good mortgage broker can help you determine who has the best programs to meet your needs. Local banks generally have more conservative criteria for loaning on land because they’re heavily regulated. Large, publicly held lenders have the ability to offer creative and flexible loan programs because they mix the risk with other loans in their portfolio.

      

Some people wonder if you can purchase your lot with a construction loan. The problem is that your house plans must be ready and approved at the time of closing, and the seller must be willing to delay closing if your plans aren’t approved yet. If you find yourself in this unlikely scenario, talk to your loan officer to see if it’s possible.

      Not all mortgage brokers have experience with land and construction loans, so be picky. Don’t trust a random online pick for this one; ask around to find the experts. Try to find a loan officer who has 100 or more loans of these types under their belt. The best way to test loan officers is to see if they ask you more questions than you ask them. If they simply try to sell you on one type of loan without inquiring about your needs, then look for someone else to help with your loan needs.

      Qualifying

      The first thing a lender will ask is whether you intend to buy the land for your own personal use. The lot-financing rates and terms for owner-occupied properties are much better than for investment properties. The lender looks to see if it makes sense for you to move to this property. If you’re claiming it to be a second home, the lender will expect it to be in a resort type area or a city other than your primary residence. Buying the lot in a cheaper neighborhood on the other side of town from where you currently live will raise eyebrows.

      The lender next assesses your qualification on the basis of your credit report, liquid assets (cash, stock, or other easily accessible forms of money), and your debt-to-income ratio (the amount of debt you carry in the form of loans and credit card balances versus your income). Your lender’s approach to these issues is very similar to how it will underwrite your construction loan (see Chapter 10 for the specifics). To make its decision, the lender wants to see, at minimum, the following documentation:

       Appraisal

       Credit report

       Three months’ bank statements

       Two years’ W-2s and recent pay stub

       Two years’ tax returns, if self-employed

Lenders may loan you a higher percentage of the purchase price based upon the quality of your other qualifications. Being able to show good credit and sufficient income might get you a loan for up to 80 percent of the purchase price.

      

Many lot lenders are the same lenders that finance construction. You apply for a construction loan some months after you get the land. If the lender sees conflicting information regarding income or assets, the lender can turn you down. Therefore, understanding the requirements for lot loans and construction loans is critically important. (We explain construction loan requirements extensively in Chapter 10.) Lenders look in their files for any other loans they made to the same borrower. If the information is inconsistent, the lender simply rejects the loan.

      

One of the advantages of working with a mortgage broker is that they can act as a filter. By looking at your documentation, a good broker can determine which lender fits best with your project. Doing so keeps you from stabbing in the dark and providing too much information to the lender that may result in denial.

      Picking a loan

      The most important criterion for your loan is the loan’s length of time. (We talk more about timing of lot loans in the section “Making sure the loan period is long enough,” later in this chapter.) Generally, your lot loan picks you based upon your qualifications. You may, however, need to choose between a fixed-rate loan or an adjustable-rate loan. Some lenders offer only fixed-rate loans where the interest rate stays the same for the loan’s life. These rates are generally higher than adjustable-rate mortgages, which have interest rates that move with a particular monetary index such as government treasury bills.

      Some people believe a fixed rate can save you money because it protects you from rising interest rates. But if you plan on building in the next few years, you’ll be taking a construction loan that pays off the land loan (see Chapter 9 for details). Because you’ll likely pay off the land loan soon with the construction loan, using a fixed-rate loan isn’t likely to save you much money. Ultimately, you need to do the math and compare the various loan payment options over the length of time you anticipate before you start building.

      

Kevin’s recommendation is to always go with the largest amount of money you can borrow for the longest period of time with the lowest payment. Doing so gives you the most flexibility for moving into construction financing by keeping the maximum amount of cash in your pocket where you need it most.

      Getting denied: What the banks won’t finance

      We can think of several situations that will eliminate conventional financing as an option to buy a lot. Some are based upon your own situation and some on the property. Here’s a quick checklist:

       If your credit score is below 640 (see Chapter 10)

       If you’ve been late on your mortgage in the last 12 months

       If you’re unemployed

       If you have no down payment

       If the property has existing buildings on it

       If the property is more than 50 acres (some banks allow only 20 acres)

       If the property has no electricity nearby

       If the property has no public access

       If the property has multiple parcels (some banks allow two)

      If your property or qualifications fall into one of these categories, don’t panic just yet. Other lending alternatives are available. Some may cost more money and be more restrictive than conventional lending, but they may be better than the thought of abandoning your project.

      Finding other land loan alternatives

      If you find the perfect lot and the bank thinks the property or your credit and income are less than perfect, you still may be able to buy it without paying all cash. Some lending alternatives are available if your property or credit doesn’t meet the bank’s guidelines.

      Letting the owner carry the burden

      One alternative way to finance a property is to have the property owner loan you the money or carryback paper. In this case, the seller acts as the