Chapter Seventeen

Financing

After you have decided on your contractor, it is time to think about financing. If you have sufficient funds to pay for the project, you are ready to sign the contract because you do not need financing.

If you must borrow money, you should arrange a loan before you sign a contract with a builder. You must have a money source before you incur indebtedness.

The principal sources of construction money are banks and savings and loans. You have the cost figure and the plans and specifications. However, there is one item that you probably have not included in costs, and that is landscaping.

It is very important, from a sales standpoint, to have a place well landscaped. If the climate warrants it, a sprinkler system should be included. I shall talk about the subject in greater detail later on.

In the meantime, your local nurseries can give you ideas concerning prices, which you should add to your cost figure.

Your next move should be to a financial institution. Take your plans and specifications and state the amount of the loan desired. If they are interested, inform them about your three bids.

The value of the project under consideration now becomes the total cost of land and construction improvements. They will lend on their appraised value of both.

Sometimes it is necessary to approach several outfits before you obtain the loan which you wish. Your first loan will probably be the most difficult. As you pile one successful deal upon another, it becomes more and more simple.

The availability of construction money varies with lenders. A certain percent of their funds are invested in your type of loan, and you may catch them with or without funds. In other words, it is not necessarily your fault if you are turned down. Keep going.

The type of loan for which you are applying has a bearing on the terms of the loan. A loan for a speculative venture is usually less than the amount allowed when you intend to use the place as your home. And the interest is somewhat higher, if you are speculating.

The fact that you intend to live in the house does not prevent you from selling it, if a good offer comes along. Your construction loan may be for a stated period of time, after which it must be paid off. Or it may automatically convert into a permanent loan, if so prearranged.

The latter arrangement is best, because there are no further financing details or costs after completion. If your house is not sold when the construction loan time runs out, you can begin to make monthly payments on the permanent loan. Thus your project will remain in good standing.

There are a couple of things which you should insist be included in your loan provisions. One is that there be no penalty for pre-payment of your loan. Another is that the loan be assumable by a third party. These matters may become quite important in the event of a sale.

In the first case, your buyer may not need a loan or may have a preferred source of money. You would not want to be penalized for having to pay off your existing loan in order to make a deal.

Secondly, if your loan is assumable, it could make for a very simple sale. They buyer could merely assume your loan payments and the loan would become part of the purchase price. The balance would either be in cash to you or any method satisfactory to you both.

Let us consider an example of a financial picture. A good balance for a project today would be; lot cost 30%; construction cost 45%; overhead and profit 25%. Thus if your lot cost $60,000, the construction cost would amount to $90,000 and the overhead and profit $50,000. The value would be the total sum of the three or $200,000.

We are assuming that we have such a deal arranged. It is very unlikely that the dollar amounts would be exactly as shown, but you could shoot for the percentages. The lot and construction costs are determined in advance through your dealings with others. They will not change.

The overhead and profit is the only category over which you have some control. Since your loan costs are part of your overhead, we should look into them.

There are many different types of loan arrangements today. They are all designed to be competitive with other loan companies and still protect themselves against major fluctuations in interest rates. They can be quite confusing since they are so varied.

Regardless of the terms of the loans, they all boil down to the fact that a certain amount of money represents a mortgage which is payable in a stated number of years. Loans of 70% to 95% of the appraised value are obtainable. The larger the percentage of loan, the greater the interest charges become.

For many years, the most practical and workable has been an 80% loan for 30 years, with no prepayment penalty and containing an assumable clause. In your project, 80% of a determined value of $200,000 equals $160,000. Since your lot and construction costs are shown to be $150,000, and your loan is $160,000 you will have $10,000 to help apply against your lot cost because that is where it was computed. But do not confuse yourself as some get-rich-quick proponents would have you do. The money is no windfall. It is part of your loan. You have borrowed it, and it will be included in your monthly payments.

I think you should look into your overhead costs at this time. It would be reasonable to expect that you could procure an 80% loan for not more than 1 point at 11% interest.

A point is actually one percent. It is a surcharge made by many lenders and may vary to as high as three points or three percent of the total loan amount. It seems to vary according to the availability of money.

Your initial loan cost would be 1 point or 1% of the total loan, which is $1,600. We have agreed to use 11% as our interest charge for construction money and the loan term is one year, in which to complete construction.

The usual method of dispensing funds is by means of five equal payments, as follows:

20% upon completion of the subfloors.
20% upon completion of rough framing and mechanical trades.
20% upon completion of the roof, exterior sidewalls and interior sheetrock.
20% upon completion of all work.
20% upon expiration of the lien period, which is usually 60 days.

Note: This same method of payment should be used whether the financing be furnished by an institution or a private individual. Inspections by the Building Department correspond with the percentage of completion required for the five payments.

Thus the signature of the Building Inspector on the space provided on the Building Permit indicates that the work has been satisfactorily completed for each trade, as work progresses. It is required that the Building Permit be permanently displayed on the job.

If the General Contractor contends that a certain inspection has been made, but not signed off by the Inspector, simply call the Building Department and verify with them.

Remember, the Building Inspector is there primarily to represent you. His job is made much easier if he is informed about any doubts that may arise. He has no jurisdiction over financing. His field entails labor and materials. Financial institutions have their own Field Man, who checks the status of each project, before a payment is made. The individual must check for himself, but in most cases he will find it a simple task.

There is one cardinal rule, which should be followed implicitly. DO NOT SUPPLY CASH IN ADVANCE.

A recent newspaper article concerning the earthquake of 1987 at Whittier, California dealt with the relatively slow progress in reconstruction after two years.

It mentioned one family which had only recently begun repairs, which were being done by their third contractor. It seems that they had engaged two other contractors, whom they paid in advance. In both cases, the individuals disappeared without doing any work.

It is difficult for me to believe that anyone can be so unthinking and reckless as to advance money for something over which he has virtually no control and for which he has received nothing.

But it is being done every day and people are complaining every day about being swindled.

Many contractors will ask for a cash advance before they start work. A prudent person will ask himself why he should pay for labor or materials which he has not received.

As an excuse for attaining payment in advance, many contractors will say they need the money to buy materials. A prudent person will decide that he has no reason to trust the contractor, if the material houses refuse to give him credit. After all, they are aware of his credit rating and his past performances.

It is preferable to have no contractor at all than a dead-beat. Many individuals represent themselves to be contractors when, in reality, they are not. Anyone can have a business card printed.

The legitimate licensed contractor will possess a card issued by the City or State, showing his picture and his name, address and the dates for which the license is valid. A Nevada license will not help at all in Arizona. The license should be issued by the State in which the work is to be done. Of course there are extenuating circumstances to almost any situation. There may be legitimate reasons why payment in advance is required for certain materials or appliances, but never for labor. In such a case your check should be made directly to the furnisher and not to the contractor. Or better yet, go to their place of business with the contractor. He will not mind, if he is on the level.

According to the payment schedule you can see that interest charges would not be assessed against the total loan amount until all funds have been received by you. You can compute interest to be 70% of the yearly straight interest rate.

Your loan of $160,000 at 11% interest for one year would cost $17,600. However, since the money was parceled out to the extent that the interest charges are 70% of a regular loan, your cost would be $12,320.

There is usually a charge for the original appraisal and office work, plus a small recording fee, and may amount to $500. Your total loan cost is $1,600 plus $12,320 plus $500 or $14,420 which is 7%. If you complete the work and someone buys the property in less than one year, the costs will be reduced.

Copyright ©1995 Robert A. MacDonald, All Rights Reserved.
Last revised: May 10, 1998.