Getting a loan to build a house is one of the most confusing and intimidating parts of building a new home on your land. From my perspective as a home builder, getting a loan is the number one hurdle for most people.
First, nobody wants to go through the painful process of gathering every financial document from the past three years and exposing every private financial detail to some stranger. Second, bankers often use industry jargon that's confusing and scary to the average person. Hopefully this article will shed some light on this sometimes unpleasant, but necessary, part of building a new home.
Rules to remember
The first thing to keep in mind is that every banker needs to make loans. It's how they make a living, and just like you and me, they all need a paycheck. The second thing to remember is that the banking industry is heavily regulated by Uncle Sam—that means there's a rule book thicker than the dictionary full of intricate procedures the banker has to follow. If they don't follow they rules, they risk a visit from the men in dark suits who enjoy extracting fines from the poor banker who forgot to do one little step. The banker has to follow the rules, and that (unfortunately) means you have to follow them as well.
Having said that, just because we all have to follow the rules doesn't mean we have to listen to industry jargon we don't understand.
The banking process
Questions for the banker
The first thing to look for in a bank is whether they are customer-focused and can explain their process in terms you understand. Interview a few bankers who do construction loans and have them describe the whole process to you—loan application, loan approval, closing, disbursing the funds, and closing the permanent loan. (Yes, there's another loan you have to get—a permanent loan, commonly referred to as a mortgage). If the banker can describe the process in layman's terms and is willing to patiently answer your questions (don't be shy about asking), he or she might be a banker worth working with.
This is the first hurdle. There are a few more to clear before you commit to a banker.
The next thing to figure out is how familiar the bank is with doing residential construction loans. The bank will refer to it as a "consumer loan," because in a regulatory sense, the loan is being made to a consumer, or an individual, rather than a corporation. A consumer loan brings with it the regulations mentioned above, and the bank's familiarity with maneuvering through this maze will have a big impact on how well they serve you.
Ask how many loans of this kind they do in a month or a year. Ask what their relationship is with their appraisers. If they say they have to pick randomly and have no relationship with any particular appraiser, they're not well-versed in construction loans. Ask which builders they work with regularly, and then call one or two of those builders and ask if the loan process goes smoothly with this particular banker. That will tell you a great deal about the banker's process and how stressful it might be.
Rates, fees, and terms
The last thing to worry about is rates, fees, and terms. For the most part, the banking business is competitive enough that you won't really find a big difference in terms of overall cost of the loan. Also, those regulations I mentioned earlier keep a pretty tight lid on fees, points, and rates. In other words, the interest rate and fees should be the last item on your priority list and probably won't make much difference anyway.
If you pick a good builder, you won't be borrowing the money long enough for even a 1% difference in rate to make a material difference. Find out what the market rate is, what the typical fees are, and make sure the banker you like is within that range.
Other items
The other items to think about are the terms of the loan and the interest payment interval. Some banks will make the loan for one year, while some will make it for nine months. It certainly shouldn't take anywhere near nine months to a year to build a house that's less than about 5,000 square feet, so either of those terms should be safe for most buyers. Some banks will ask that you make your payments (interest only, unlike your house payment you'll make on your permanent loan) monthly, some quarterly. If quarterly, you might only make two payments the whole time your house is being built. That can make the cash flow easier for you, since the remaining interest you owe at the end will get paid by your permanent loan after your house is complete.
Process of applying for the loan
Once you've chosen a bank, you'll go through the excruciating process of applying for the loan. Every banker will ask you for a million documents initially and will probably come back a few times asking for more. When this happens, just take a deep breath and know there's a method to the madness. (OK, the method might not be the most efficient, but remember those regulations I told you about?)
What happens within the bank is the loan officer (the person you're dealing with, who is essentially the front-line sales person) sends all your documents to the underwriter, whose job is to verify everything and keep the bank examiners happy. The bank keeps the underwriter locked away in some windowless room to keep him or her away from customers— the underwriter is the bad cop in the good cop/bad cop scenario. When he or she has a question, the underwriter goes back to the loan officer and asks for some clarifying information, thus the source of the irritating barrage of requests from your loan officer for yet another document.
There's a reason for the proverb that says "patience is a virtue." Patience is the only thing that's going to get you through this phase with your sanity intact.
The bottom line is that the loan application and approval process is indeed a painful one. If you know that and expect it up front, it will make the process less stressful. Find the most customer-friendly banker you can, don't blame him or her for the endless paperwork, hunker down, and get it done. You'll be glad you did.
