How to Choose a Log-Friendly Lender

Choosing a lender is one of the most important decisions you will make on your path to your dream log and timber home. The right choice here can save you thousands of dollars, not only in closing costs, but also over the life of the loan.

Most log and timber home buyers finance their purchase. The tax benefits alone makes getting a mortgage attractive even for those few who have the ability to pay cash to buy and build. However, even though interest rates are still hovering at historical lows, the days of “no money down/no equity required” are gone. Like everyone else, lenders need to protect their investments and doing so means reducing risk with sizeable down payments and proof of collateral.

Obtaining financing can be complicated, like a puzzle with many pieces. Any change to an individual puzzle piece, will affect all the other different pieces. Some of the information in this deciding on a lender involve decisions you haven’t yet made, such as deciding on a design and choosing a builder. But we wanted to make you aware of all the information lenders will need before they approve your loan.

When it comes to your individual financing program, you will have your choice from a vast array of different options. But they basically boil down to two kinds: fixed rate and adjustable. To choose which one is best for you, you will need to analyze your priorities. Do you need a mortgage interest deduction on your taxes? Will this home be a permanent residence or a vacation home? Is your goal to pay it off quickly or over the long term? Your answers and advice from your lender can help you sort out the best program.

Be aware that the lending landscape has changed dramatically. If you have purchased a home in the past few decades, then you will likely recall terms like the Truth in Lending Act or TILA and the Real Estate Settlement Procedures Act or RESPA.

But all that changed on Aug. 1, 2015, with the enactment of the Dodd-Frank Act, which was signed into law by President Obama. Lending procedures that have been around since the 1970s were replaced with a new rule called Know Before You Owe mortgage initiative. This is based on TRID, or the TILA-RESPA Integrated Disclosure rule. Additionally, the previous use of the Good Faith Estimate and Truth in Lending disclosures were eliminated in favor of a new single Loan Estimate form, or “LE,” and the HUD-1 Settlement Statement was replaced by the Closing Disclosure, or “CD.”

These new rules mean the clock is ticking once you submit your loan application. Home buyers applying for a loan today receive their Loan Estimate or LE from their lender three business days after a lender receives your loan application. Additionally, your Closing Disclosure or CD from your lender arrives three days prior to closing, so you have time to review it thoroughly before signing any documents at the closing.

Previously, you reviewed the HUD-1 Settlement Statement at the closing table with your loan officer present and changes were made on the spot. Now, if there are changes, your lender must make the revisions and provide you with yet another 72 hours to review that new statement before closing.

The intent behind these new regulations is not to cause you undue stress or delays — it’s to make it easier for home buyers to understand the terms and streamline the loan application process by placing all the relevant details in one document. In addition, the LE and the CD look very similar so you can better compare your actual charges in the Closing Disclosure to the estimated charges in the Loan Estimate when you applied for the loan.

Each document provides actual dollar and cents amounts, rather than rounding to whole numbers as it was done under the previous guidelines. Since TRID went into effect in 2015, many home buyers feared the new rules will delay closings or make it harder for buyers to qualify for a mortgage. These fears proved to be unfounded. These guidelines are in place to protect you from mistakes or other factors that could cause you to default on the loan, placing both you and your lender at risk.

What financial information will you need to gather to go lender shopping? Here’s what lenders say you will need to help you qualify for a loan:

• A 700+ credit score is ideal
• Two years of W2, 1099 and full 1040 (federal, not state) forms, both personal and business, plus K-1 form (if applicable)
• Thirty days of paystubs or monthly pension advisements
• Your Social Security or pension award letter
• Two months of complete bank statements for accounts, including savings, checking, stocks, etc. — every page, not just the summary
• Your most recent quarterly 401k statement and/or other retirement accounts
• A letter of explanation on any negative credit (if applicable)
• A mortgage statement for your current home and any additional properties you own
• An estimated contract for your new log and timber home plan to justify the amount you want to borrow
• A contract for the land on which you intend to build (a HUD-1 prior to October 2015; a CD after that date)
• A 20% down payment for conservative lenders; others will allow as low as five percent

With this information, lenders will look at your income-to-debt ratio, any large or unusual deposits, as per The Patriot Act, and your work history to help them determine your ability to repay the loan. Ratios can fluctuate between lenders. Most lender’s will allow a 43% total Debt to Income ratio for purposes of a Qualified Mortgage. Some lenders can also offer non-Qualified Mortgages (debt-to-income over 43%) with compensating factors such as a high amount of reserves or a high amount of discretionary income.

Besides your financial status, lenders will want to know exactly what you’re going to build, how much it will cost, how long it will take and who’ll be doing the work. This will help the lender estimate the home’s potential value and determine how much the lender will lend. Here’s some information you’re likely to provide to obtain a loan.

• Building permits: Construction documents that comply with local building codes will have to be presented to the local permitting office for approval before you can obtain a building permit.
• Sales contract for the log and timber home package: This should include a complete bill of materials that your log and timber home producer will supply.
• Plans and specifications: A floor plan in a producer’s catalog isn’t enough. Lenders will want to see construction drawings, detailed materials specifications and descriptions of building materials. These documents will tell the lender exactly what is being financed and help the loan officer assess its value.
• Cost estimates: You’ll need copies of written bids and estimates to determine a detailed cost estimate.
• Builder contract: If you are hiring a general contractor to build your home, you must have a copy of the agreement showing costs and specifications. The majority of lenders prefer to approve a loan if a professional will be handling construction.
• Statement of your construction abilities: If you do intend doing some or all of the work yourself, supply the lender with information on your qualifications, such as photos of projects you’ve completed or other evidence that you’re capable of completing the construction of your log and timber home. The more you can reduce risk to the lenders, the better your chances of getting approved.
• Survey or plot plan: This plan shows the exact location of your land and provides a legal description of the property.
• Land deed: This document shows the title and mortgage information on the property where you intend to build.
• Information on the log and timber home producer: Your contract explaining what the log and timber home company will be providing, including a materials list and a copy of the company’s construction manual.

Most buyers build their dream home by having two loans; a construction loan and a mortgage or the combination of a construction-permanent loan. The advantage with the latter is one closing cost. Once the home is constructed, the loan is automatically rolled into a typical mortgage payment.

Lenders that offer a two closing do so because they cannot the resources to fund the construction period during a one-time close. Two closings is a band-aid option to get the financing for the project, but it certainly adds more costs for the home buyer. This usually involves two lenders in the transaction, which may not be obvious to the home buyer. Typically a bank is involved in funding the draws during construction and another financial institution or broker handling the permanent mortgage through another source.

Another factor to consider when deciding on a lender is when to lock in your interest rate. There are a wide variety of options out there that can include locking the permanent loan rate at application, locking when the appraisal is approved or floating your interest rate during construction.

With a one-time close, most lender’s will require a rate to be locked before closing. If a lender is offering the home buyer to float their interest rate, there is usually a rate cap built in to ensure the home buyer doesn’t have to pay more money by a sudden increase in interest rates. At issue is the eight to 12 months it can take for the home to be completed and converted into a permanent mortgage. This time gap is when rates could go up.

Before you pay any loan application fees, take the time to go over your financial standing and ask lenders if they have experience in financing log and timber homes. It’s helpful to have a specific mortgage plan in mind when shopping for a lender, so that you are making direct comparisons. Most of your shopping can be done over the phone, on the Internet or by email.

Borrowing money to build a home is slightly different than borrowing to buy an existing home. Whether you are an owner-builder, owner-contractor or will be having your log and timber home professionally built also makes a difference. This is because of the higher risks associated with construction loans, especially when owner-builders are involved.

Another major change in the lending landscape is that the national banks and many regional lenders no longer offer construction loans for home building. This market shift happened because construction loans offer higher risk with lower returns. There was the added burden of having their most experienced loan officers handling construction loans, which is why the larger lenders got out of the business altogether.

Instead home buyers will need to approach their local lenders, credit unions, Farm Credit Service or regional banks. So your first question is if they offer construction or construction-permanent loans.

How construction loans differ from mortgage loans:

• Usually secured by land
• Based on appraisal of construction drawings and selling prices of comparable value homes
• Loan disbursed in a series of draws as work is completed
• Higher risk for lender because loan is secured by land only until house is completed
• Higher interest
• Short term (usually six to 12 months)
• Monthly payments for accrued interest only
• Paid off by proceeds from mortgage loan at settlement on completion of home

Conventional mortgage:

• Secured by home and land
• Based on appraised value of home checked against selling price of comparable value homes
• Loan disbursed in a single payment at settlement
• Lower risk for lender because loan is secured by house and property
• Lower interest
• Long term (usually 15 to 30 years)
• Monthly payments include both interest and principle
• Paid off by principle portion of monthly payment over life of mortgage

If your lender doesn’t offer construction loans, an option is to use your current home or your investments as collateral with the lender. Buyers have also used home equity lines of credit (HELOC) on their current home to finance construction.

Before granting construction loans, lenders evaluate the plans, budget and schedule, as well as the builder’s abilities to complete projects on schedule. Once the loan is granted, the lender disburses the money according to a draw schedule, a series of payments for work completed. Progress is verified by on-site inspections, which determine that the labor was performed and specified materials were used.

Typical draw schedules include five or six payments. The first might be made when the foundation is completed, the second when the log shell or timer frame is erected. The next-to-last draw is completed when the house is completed and the certificate of occupancy issued. The last draw generally comes 60 to 90 days after completion to allow sufficient time for any subcontractors or suppliers to have filed mechanics’ liens. As the balance of the loan dwindles because of these draws, the interest amount also goes down thanks to this lower balance.

A key difference between construction loans for log and timber homes and other custom homes is that the log and timber producer expects to be paid a substantial down payment before cutting and shipping the logs or timber frame. We advise you to avoid making a large down payment for your log and timber frame package until you’ve secured financing for construction.

Some lenders view a log package or timber frame as just another load of lumber or as work under way at the producer’s plant. They’ll release funds when the manufacturer requests them. In other cases, the lender may refuse to release any money until the package is delivered to your building site. If this occurs, ask your lender to issue a promissory note to the log or timber frame home company guaranteeing that payment will be made on delivery. The lender can wire transfer the money the same day as the log package or timber frame arrives on site.

Another substantial challenge log and timber home buyers face when financing their new home is the appraisal process. Appraisers need comparable sales, or “comps” in appraiser speak. In a perfect scenario, an appraiser would have comparables within the same neighborhood of the same style, square footage, age, lot size, updates and upgrades, exterior amenities, bedrooms and bathroom count, condition and quality of construction, and all sold within the last 90 days. (This NEVER happens, by the way.)

Therein lies the problem, because many log and timber homeowners rarely sell their dream homes, usually bequeathing them to family members.

At issue is what ultimately happens to your mortgage loan. Some lenders will keep a mortgage in-house, or within their own investment portfolio. If your lender plans on selling the loan on the open market or to Fannie Mae (the Federal National Mortgage Association), the loan has to conform to certain guidelines.

These guidelines can include proximity, status and date. For suburban neighborhoods, comps can be from one to five miles away. For rural neighborhoods, comps can five to 20 miles away. These distances can even be stretched if the appraiser can find an actual similar log or timber home recently sold. Most underwriter’s and investors will allow for a little further distance when finding a similar type home.

Status and date are also part of the appraiser’s formula, which include at least three closed comps, two of which were sold within 12 months. Many lenders now also require at least two pending or active comparable listings as well.

If the appraiser is using custom built homes (not log or timber) the appraiser does need to keep within prescribed distances. A portfolio lender or a bank that intends to keep the loan in-house can also make some exceptions to the appraisal guidelines, allowing farther distances, allowing for older comparables and may be more flexible in accepting comparables.

If comps are used that are outside of these parameters and the requirements of the lenders, the appraiser must be able to explain why. Fannie Mae holds the lender responsible for the accuracy of both the appraisal and its assessment of the marketability of the property.

Combine all these requirements with an appraiser who may be unfamiliar with log and timber construction and your new dream home could be undervalued during the financing process, before you’ve even broken ground on your project. Lenders say this happens as much as 50% of the time with log and timber appraisals.

Typically buyers put 20% down, plus land equity into the deal. However, if the appraisal comes in low, you may have to come up with more money down. Some lenders will increase their lending rate to 90 percent of the cost of the home to help offset the additional money needed when an appraisal comes in short.

The bottom line is if log and timber homes are plentiful where you are building, you will likely not have any problem with the appraisal. If log and timber homes are not at all plentiful or recently sold, you will likely run into issues with the appraisal and you may have to come up with more money to earn your loan approval.

However, to help tip the scales in your favor, there are some resources you can share with your appraiser before they start scouring the market for comps. Start by informing your appraiser that log and timber homes need not be compared to other log and timber homes. They should be compared to other custom homes recently sold, as per the Fannie Mae FAQ on appraisal property report. Refer the appraiser to questions 25 and 26, which have been recently updated.

https://www.fanniemae.com/content/faq/appraisal-property-report-faqs.pdf

Q25. UPDATED Are loans secured by unique or non-traditional homes eligible for delivery to Fannie Mae? Yes. Fannie Mae does purchase loans secured by unique or non-traditional housing types, such as, but not limited to, “tiny” homes or “container” homes, log homes, earth berm homes, and geodesic domes, which can be located in all areas, including rural locations. Loans on these types of properties are eligible for delivery to Fannie Mae provided the appraiser has adequate information to develop a reliable opinion of market value and the property meets other eligibility requirements

Q26. UPDATED Is there a required number of comparables that must be of similar design or appeal as the unique or non-traditional home that is being appraised? No. There is no requirement that one or more of the comparables be of the same design and appeal as the property that is being appraised. However, appraisal credibility is enhanced by the use of comparables that are the most similar in design and appeal.

Another resource is the free “Appraising Log Homes” white paper.

Typical draw schedule for a $450,000 construction loan*:

* Number of draws and percentages vary among lenders. Obtain a copy of the draw schedule and discuss this with your builder. If you are acting as your own builder, compare the draw schedule with your cost estimate summary to be sure it will cover costs as they are incurred.