A Tale of Two Wallets
Kevin J. Daum

This article was originally published in a 2007 edition of Log Homes Illustrated magazine.

Every hopeful Log Home owner needs a piece of land to put it on.  Some are fortunate enough to have acquired land from family members but most people will need to find that perfect lot and then find a way to pay for it.  Structuring the financing correctly on your land can have a major impact on your ability to finance the construction of your log home.  Consider the tale of two couples buying their dream lots.

Fred and Nan Smith finally found the lot of their dreams.  It was a 5 acre wooded slice of heaven at the base of the foothills.  The lot was for sale for $80,000.  They had been saving their money for years in hopes of creating a log home in which they could retire.  After saving for years Fred and Nan had put away $100,000.  They both had pensions coming from their Government jobs so they believed they could manage financially once they were set with a fixed income.

The Smiths believed themselves to be fiscal conservatives and shied away from debt at every opportunity.  They knew they would need some sort of construction loan to get their project built and remembered hearing that banks wanted land free and clear before loaning money for construction.  So when the time came to purchase the new lot, Fred and Nan had no reservations about paying cash for the project and avoiding financing on the land.

With the land all paid for they headed to their favorite Log Home dealer to design their home.  The package was a $200,000 all inclusive deal and the dealer had provided several reputable log home builders for Nan and Fred to work with.  The log home company only needed a 10 percent deposit to get started on engineering the drawings.  The Smiths paid the log home dealer $20,000 to get started figuring everything else would be financially taken care of when the construction loan was put in place.

Cash was tight now for the Smiths.  They had emptied their savings account on the lot and log home deposit.  The permitting process had required some more money which they were able to squeeze off some credit cards with low interest figuring they could pay them back from the construction loan.  The builder had also called explaining that while the log home package did include the shell as well as doors and hardware, some of the finish items such as cabinetry and fixtures would be ordered separately and would require deposits in advance to assure the deliveries on time during construction.  Again the credit cards were a good source of this temporary funding.

Finally the log home dealer called to let Fred know that the engineered drawings were about ready.  Happily Fred sought out to find construction financing.  Unfortunately his first meeting did not go so well.  The loan officer was pleased with the projected value of the Smith’s property but was not so happy about their financial condition.  The Loan Officer explained that the bank had a minimum requirement for cash reserves in order to qualify for any construction loan.  Since Fred and Nan had put all of their money in the land and the log deposit they no longer met the minimum of 6 months payments in reserve.

Fred and Nan were shocked!  “What about the land value?  Doesn’t that count for anything???” Fred asked.  “Not really.” replied the Loan Officer.  She explained to the Smith’s that liquidity was the best way to assure the bank that the project would be completed and that the loan would be repaid.  Fred and Nan were upset and confused.  They spoke to five Loan Officers and all five gave the same response.  On top of that they found out from one who ran their credit that the use of the credit cards had dropped their credit scores under 700 points making it even harder to impress the banks.

Just when they were about to give up Steve a mortgage broker came up with a plan.  He suggested that they take a loan out on the land to pay off the credit cards and replenish their cash.  “We already tried that!” Nan exclaimed.  “None of the banks would give us cash out on a lot.”   Steve explained that as a last resort they could take a hard money loan on the lot to get about 50 percent of its value in cash.  It would be expensive at 6 points and 12 percent but it wouldn’t be for very long and since it was only about $4,000 in costs it would be small price to pay for getting their project moving.

The Smiths weren’t happy but saw the hard money loan as the only alternative.  The $36,000 net cash was just enough to pay off the $10,000 in credit cards and show the bank the reserves they desired.  Their cash ran tight throughout the project but they were able to struggle through.

When Marty and Belle Golden found their dream piece of land they had done their homework on how banks look at people’s finances.  Before they got started they wanted to be sure they would have the financial wherewithal to afford the project all the way to the end.  They read up on the subject and interviewed Loan Officers while attending Log Home Expos before even approaching a real estate agent to help them find a piece of land.

They learned early on that every construction project requires cash along the way even when using construction financing.  They also learned that the current value or equity of the land was nearly irrelevant in qualifying for a construction loan.  They found out that the banks were primarily interested in a borrower’s good credit and cash on hand without which the banks would not make a loan.

Marty and Belle worked with Sharon, their mortgage broker to free up equity in their existing home so they would have plenty of cash on hand.  Sharon had been in the loan business for many years and was aware of the old wives tales out there about banks wanting lots paid off before providing construction loans.  Sharon knew fully well that the markets for loans had changed dramatically in the last 20 years but few people actually knew the new rules. 

Before they started looking for land the Goldens had Sharon pre- approve them for a lot loan.  Sharon was able to arrange 90 percent financing for a five year period.  This was more than enough time to finish their plans and arrange for their construction loan.  The lot loan was close to prime in interest rate and low in points so that Marty and Belle could afford to carry the property while they started working with their Log Home Dealer.  The Goldens had discussed the loan with their CPA who pointed out certain tax advantages from the interest and points paid.

Recognizing the value of diversification Marty worked with a financial advisor to make sure that he had invested his cash in a conservative manner.  By diversifying the funds Manny was able to protect his cash and receive income to offset a significant portion of the land loan payment.

When it was time to qualify for a Construction Loan Marty and Belle were able to easily present a winning profile to the lenders.  Due to their strong liquidity and excellent credit, Marty and Belle were offered the most competitive rates without having to provide any income documentation. 

The cash on hand came in handy throughout the process.  Not only were they able to pay the deposit on their log package easily, but Marty enabled his contractor to pay the subcontractors weekly negotiating better prices.  The contractor was able to secure items early in the process whenever he found off season bargains for materials and fixtures.

By the time the Goldens finished their Log home and rolled their loan into permanent financing they had moved their remaining cash into long term investments providing them with higher yields for their retirement.

Ultimately both the Smiths and the Goldens were able to settle into their dream log homes and retire comfortably.  The Smiths undoubtedly caused themselves much unnecessary stress and difficulty by not doing their homework before following a particular financing path with their lot.   Since banking is a dynamic industry, lending guidelines change as the economy and investment markets change.  One thing that is steadfast throughout constant change, liquidity is the only sure thing to make you like…Golden.

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.