lmarie218

Using land as equity for down payment of new construction

lmarie218
5 years ago

My husband and I are building a home on a lot he inherited many years ago. He has owned it for about 4 years, free and clear. It's currently appraised at $106,000.

A few months ago we began the process of meeting with banks and shopping around for rates. We found a local bank with a good rate and went for it.

We found a reputable builder and bought house plans. The cost to build our home will be $350,000. We had no problem getting approved by our bank of choice for that amount. Since our intention is to use our land equity as the 20% down payment, our understanding was the bank would loan us 80% of the cost to build (350k) and we would be responsible for the other 20% (70k) plus a 5% contingency fund incase the project runs over (~18k). With the land equity of 100k we have that plus about 12k left over in equity.

We are in the final stage of the loan approval this week. Our combined appraisal for the lot and house came in at $390k. The bank is now telling us they will loan us 80 of THAT value (312k) and we must come up with 60k cash to cover the rest. (20% plus the 5% contingency)

Why in the world would they base the 80% they will loan us off the appraisal value, when we own the land out right? Now they've used our equity there and are telling us we can't use it as a down payment? We obviously don't need to borrow on land we own. We should be borrowing 80% of the construction cost, not the total value. Anyone have experience with this? We are about to pull out completely with this bank, as others in the area clearly state that they will loan up to 80% of the appraisal value OR cost of construction, whichever is less.

Comments (145)

  • bry911
    5 years ago

    Chris, now that you dumbed it down for me, I understand. The car loan really helped me. So I have some extra money and I would like to make you an offer.

    Trade your land to me, just like it was a used car you were trading in, and I will give you a loan to build a decent house on it...


    Best Answer
  • Lindsy
    3 years ago

    Whiskeyboy clearly said they own the land outright, no mortgage. So the replies after his post don't apply to his scenario. I'm chiming in because I'm fixing to dive into the same thing of getting a construction loan on property we own free and clear. It is confusing largely due to the language used in conversation between builders, etc. Just as a poster said here above that you're using your land "in-lieu" of a down-payment. That's a statement used a lot that really confuses people, myself included.

    So, Whiskeyboys case I don't understand why the bank would add $50K to the loan if it doesn't have anything to do with the cost of building the house..?

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  • amberm145_gw
    3 years ago

    He never specifically said "no mortgage". If the bank has already given the builder $50k to start the build, then they essentially have given him a $50k mortgage on the land. He said he thought they were going to put a $50k lien on the land, which they would only do if they were loaning him money using his equity in the land as collateral.

    Note that it's collateral. He hasn't given the bank his land like he would have given the builder $50k cash. He's only promising them to pay back that $50k, and in the event he doesn't, the bank has the right to take the land.

  • whiskeyboy06
    3 years ago

    Lindsy, that's what I don't understand either.

    amberm145_gw, we paid cash for the land in April. No mortgage.


    Our understanding from the lending company was that we could use that cash value towards our 20% down payment and they would put a lien on our land. Instead they are increasing the "purchase price" of our home to account for that 50,000, which in effect is not really allowing us to use the land but does, however, inflate the loan amount, closing costs, and down payment significantly.


    I've been arguing with them all day and so now, we are just going to leave the land out of the mix completely, pay 5% down and borrow 15% in equity and be done with it, leaving our purchase price at 417,000 (financed being 336,000).


    Does this make sense to anyone? I've talked to two other loan officers today with different companies who are also very confused by it.

  • whiskeyboy06
    3 years ago

    I guess I should add that this is the mortgage, not the construction loan. The construction company held that. House is already built and appraised at 510,000. We need to pay the construction company 417,000, which was the cost to build and our contract price with them.

  • Andy
    3 years ago
    last modified: 3 years ago

    The cost to build was 467,000 (construction plus lot cost) and the loan amount is 417,000. I suspect you had a $50k credit coming at closing but they didn't do a good job of explaining it to you.

  • amberm145
    3 years ago

    You didn't buy the land from the construction company, did you? So they can't be telling the bank you still owe $50k on top of the $50k you already paid them for the land? And there's been no other payment from the bank?

    In that case, tell the bank you need a mortgage for $417k for improvements made to your land that's now worth $510k. The $50k you were "allowed" is a meaningless number if it's not representing an outstanding balance somewhere that you still need to pay.

  • amberm145
    3 years ago

    Even if the lot cost from the construction company was $50k, Whiskey paid cash for that. The cost to build is still $417k.

    Maybe the misunderstanding is that you paid cash and the bank is assuming you only got a credit?

  • Andy
    3 years ago
    last modified: 3 years ago

    BTW, you can't put a lein on just the property once you build a house on it...the house is inseparable from the property. The property is now "improved".

    With new builds, when the appraised value is greater than the cost to build, often the bank will only loan up to a certain percentage of the cost to build, rather than the appraised value. Let's pretend the number is 15%. In that scenario, they would be willing to loan up to $396,950 of the $467,000 that it cost to build. The cost of constructions is $417,000, so you would owe a down payment of $20,050 (plus probably $10-15k in closing costs).

  • Andy
    3 years ago

    Even if the lot cost from the construction company was $50k, Whiskey paid cash for that. The cost to build is still $417k.

    It doesn't matter when you paid it, the cost for the lot is part of the cost of constructing the house.

  • Andy
    3 years ago

    I can almost promise you there was going to be a $50k credit on the buyer side of the closing sheet.

  • amberm145
    3 years ago

    But if he didn't buy it from the builder, it's irrelevant to the cost to build.

    If he did buy it from the builder, and paid cash, and the final bill is $467k, $50k was already paid and it would be a $417k loan from the bank.

  • whiskeyboy06
    3 years ago
    last modified: 3 years ago

    We didn't buy it from the builder. We bought the lot and then picked a builder. The construction company had absolutely nothing to do with the purchase of the land.

    amberm145, the credit/cash bank assumption is the really crazy part. We had to provide proof of purchase to the lender and the cancelled check where we bought the land.

    Andy, they were giving us a "credit" from the builder, which to me is very weird. I would understand that if we purchased the lot from the builder or if the builder purchased the lot for us and we gave them money. Instead, this was our land that we hired a construction company to build on. The construction company didn't need to be giving us "credit" for the land. It was all doctored paperwork to make it look that way so that they could "give" us 50,000. I agree that it wasn't explained very well.

    The hardest part for us to wrap our heads around was the closing documents, which is why we just left the land out of it. Basically, the closing documents stated that we had a 467,000 purchase price and a 50,000 credit, making our 20% 93,000 and our loan amount 376,000. That was not what we were told at the beginning by the mortgage company (forget about the builder, they just want their 417,000 and they are good). The mortgage company made it sound like our purchase price was 417,000 and they (the mortgage company) would essentially "buy" our land from us at 50,000 as part of our down payment. The 20% would be 83,000 with a loan amount of 336,000. This made sense to me since you can't separate the land from the house anyway. And at an appraisal value when it was all completed of 510,000, that was fantastic, because even if we defaulted, the bank didn't run much of a risk at all.

    After today, I just feel like the loan officer told us what we wanted to hear so we would go with them and now, because interest rates have jumped and ours is still locked, we are stuck with them.

  • Andy
    3 years ago

    But if he didn't buy it from the builder, it's irrelevant to the cost to build.

    Not sure why you think this but that's not the case. My lot was purchased almost 3 years before I built, from a private party, and contributed toward the cost of building. I'm not sure in what situation you would not count the cost of the land in the build cost. You can't build without a lot.

  • Andy
    3 years ago
    last modified: 3 years ago

    So, imagine you owed $50k on the land, rather than paying cash. The total cost would be $50k to pay off the land note, and $417k to build. $467k total. You would be expected to come up with 20% of $467k, which is $93,000. Instead, because you already paid the $50k for the land, you in reality only owe $43,000 down.

    I'm not sure I understand the final arrangement though:

    I've been arguing with them all day and so now, we are just going to leave the land out of the mix completely, pay 5% down and borrow 15% in equity and be done with it, leaving our purchase price at 417,000 (financed being 336,000).

    Do you mean there's a second note for the 15%?

  • whiskeyboy06
    3 years ago
    last modified: 3 years ago

    Nope, they are having us borrow that against the appraisal value. That's what is really screwy. We told them we could come up with 10% if they would let us use the land for 10%. They said we could do that and just borrow the other 10% instead of coming up with it in cash. It was all really weird.

    Honestly, I truly believe he was bumping up the cost to have a larger loan and make more money off of it. He was very angry that we wouldn't just sign the papers with the loan amount of 467,000. So instead of including the land, we have a loan amount of 417,000: providing 20,850 in cash and borrowing equity of 62,150, making our amount financed 336,000.

    I really think we were mislead in the first place and I'm not sure if it was intentional on his part or not. But after the way the loan officer reacted and the process we have been through with him over the last two months, I'm of the opinion that he said what we wanted to hear so we'd go with them, even if he wasn't sure they could actually deliver on those promises.

  • Lindsy
    3 years ago
    last modified: 3 years ago

    So, imagine you owed $50k on the land, rather than paying cash. The total cost would be $50k to pay off the land note, and $417k to build. $467k total. You would be expected to come up with 20% of $467k, which is $93,000. Instead, because you already paid the $50k for the land, you in reality only owe $43,000 down.

    ^^^^^

    This is exactly the language that is so freaking complicated and misunderstood. WHY would someone that has owned a piece of property free and clear from any bank have anything to do with the cost of that land they bought say three years ago have any effect what so ever on the loan to build the house? The bank should only be loaning the cost to build. What does the paid off land have anything to do with anything EXCEPT proving you have collateral..? The land is paid for!!! Why is this 50K from land being ADDED anywhere??

  • Lindsy
    3 years ago

    I think we all understand how it works when you are buying the lot at the same time of build or still have an existing mortgage on the lot you are building on. Those of us without either of those situations, just a piece of property we own with lien release proof get so confused. They (banks and builders) have said "we will use part of your land equity as part of your down payment", but in fact that it seems to never actually happen like that.. So HOW does it happen? Does having a property currently worth 200K market price have anything positive to do with when we take out our mortgage, or should we assume the equity means nothing, you don't get to use any equity for any part of a down payment? If that's the case, great. I just want to be able to understand, and sadly I fear my not understanding this means I'll "be taken to the cleaners" by the bank by them using my ignorance on the situation. I've Google too... I guess I need to get a real estate attorney to help me with this..?

  • whiskeyboy06
    3 years ago

    Lindsy, I agree completely. They claim we can use the land as part of the down payment, but our bank was jacking up the price and giving us a "credit".


    At one point, I said to the lender that he wasn't letting me use the land as a down payment and he claimed he was. I'm very tired of talking in circles with him. I just wish he had never offered that to us as an option in the first place.

  • PRO
    Sophie Wheeler
    3 years ago
    last modified: 3 years ago

    "Down payment'' is a complete misnomer.

    Market price of the land as a lot has little to so with the appraisal price of a house and lot joined. Once built, the two can't be separated, or valued without the other. And the cost to build has less to do with the dollars you pay for the project than it does the price the bank could get for the land and house if you defaulted. They can't sell the lot as a lot when it has a house on it, so he ''value'' as a lot is gone. It's about the value of the two together should the bank end up owning it.

    Lot cost 50K, paid in full.

    House build cost 300K.

    Appraisal of the house, as built to plans, on the lot is not automatically 350K. It will only appraise for maybe 320K. Or, if you're putting in a lot of sweat equity, it might appraise for 360K. Neither number has a single thing to do with what the project actually costs you.

    What the bank will loan you has to do with the appraised cost, as built. Not what you paid for it all totaled.

    First scenario, the bank will loan you 80%of 320, or 256K, and you need to bring 94K to the table. Second scenario, the bank loans you 288K, and you need to bring 62K to the table. Both builds cost 350K out of pocket. But, what buildings cost, and what they appraise for can be very different.

    This really comes into effect when someone builds a larger, fancier house, in a neighborhood of entry level starter homes. The 250K surrounding homes do not care that it cost you 400K to build hat bigger fancier home. Your home would only sell for 275 maybe should the bank be forced to foreclose it and sell it.

    That appraisal number is the ONLY number that you need to concern yourself with. And you may need to reverse engineer if you stuffed your house full of upgrades. Or else pay for them with that 20% contingency reserve that you should also have in addition to the 20% appraised cost down payment.

  • Andy
    3 years ago
    last modified: 3 years ago

    Honestly, I truly believe he was bumping up the cost to have a larger loan and make more money off of it. He was very angry that we wouldn't just sign the papers with the loan amount of 467,000. So instead of including the land, we have a loan amount of 417,000: providing 20,850 in cash and borrowing equity of 62,150, making our amount financed 336,000.

    If they're willing to loan against the appraised value, I'm not sure what the concern is? You should be able to finance $408k while retaining 20% equity.

    Edit: Sophie, he stated earlier the appraisal was at 510k.

  • bry911
    3 years ago
    last modified: 3 years ago

    I am so confused. There are two separate things that you are switching back and forth between.

    (1) build cost - The total consideration given for all items in the house. Many years ago when I did build a house this included land (that I owned outright) and all charges associated with building the house. It also included cabinets that I bought a year before, tile that I bought at a yard sale and appliances that I got on clearance almost two years before installation. It was literally every penny I spent on anything that would eventually be part of the house or the land.

    (2) loan amount - The amount of the principle plus financed charges that you borrow from the bank.

    The two things are completely unrelated. It doesn't matter what is in build cost! Banks use it to calculate the cap on the loan. The purpose of calculating both numbers has to do with conforming vs. non-conforming loans. Technically, there are a different set of rules for cash out financing and the bank is on the hook for more money in default. Also it keeps people from cutting corners in the build to get cash back at closing above reimbursements.

  • amberm145
    3 years ago
    last modified: 3 years ago

    I think someone, possibly me, is confusing "cost to build" with "total cost". When the lot is pre-paid, what you really need to consider is the cost of labour, materials, and builder's profit. However, there's a rule that the bank will lend you based on the appraised value, or total cost, whichever is lower. So, the bank was offering to set the total cost at the cost to build, plus what you paid for the lot. Doing that, they can loan you 80% of $467k, or $373,600. And since the builder needs to be paid $417k, you pay a down payment of $43.4k on top of the $50k you've already put into the property.

    But because you've insisted the cost to build is $417k (which I personally agree with), the bank is loaning you 80% of THAT, and you now need to come up with $83,400 to cover the builder's bill. If you've got access to that, and it's earning less in investments than you'd be paying in interest, then you're better off going that way and borrowing less.

    However, the key difference is that the second way does not consider the value of the land in your calculations. The $50k already spent has brought the "cost to build" down, and can't be used again to reduce your loan amount. (That's where a lot of confusion comes in for many people.)

    Interesting that they're still basing the max amount of the loan on the amount spent rather than appraised value when the house is complete. I know it's common on a construction loan because of a higher risk. But at this point, it's a finished house. If you were to sell the house tomorrow, the buyers would be able to get $408k from the bank, as 80% of the $510k they paid for it. It's odd that the bank won't give you $408k, given that their risk is the same at this point.

  • bry911
    3 years ago
    last modified: 3 years ago

    I've been arguing with them all day and so now, we are just going to leave the land out of the mix completely, pay 5% down and borrow 15% in equity and be done with it, leaving our purchase price at 417,000 (financed being 336,000).

    I see no reason to take out two loans. You basically just threw your checkbook at what you thought was the problem.

    The credit at closing means that you were going to have to pony up $43,400 and have a loan of $373,600 plus any loan origination fees. Now you are paying higher interest rates to borrow $396,150. You actually just increased your payment for no discernible reason.

  • D Ahn
    3 years ago

    @whiskeyboy, I think your gut feeling is right. Your mortgage broker is using a fake figure, "cost to build," to write a larger loan than you need in order to increase their commission. It's generous of them to offer to loan you $467K (91.6% LTV), but since you only need $417K, in the end it will turn out to be a cash out mortgage, with $417K due to the bank holding the construction loan note and $50K due to you at closing. But you will have paid higher fees.

    Agree with bry911 that "borrowing equity" - assuming you're talking a smaller second mortgage - makes no sense. People take out second mortgages to get around PMI, but the second mortgage bank has equity in the home, not the borrower. With an appraised value of $510K, 20% equity is $102,000 to avoid PMI, so you can get a loan of $408K and bring $9K plus closing costs and not have any PMI. Sounds like they're trying to get two commissions, one for the main note and the other for the second.

    I strongly urge you to stick to your guns and only get the loan amount you need. I don't know how much extra commission they would make, but they shouldn't be extorting customers to borrow more than they need.

  • amberm145
    3 years ago
    last modified: 3 years ago

    David, the bank isn't actually giving them any extra cash. They're only reducing what Whiskeyboy would be required to come up with cash for. (I thought the same thing at first, until I realised they're only using it to come up with their "80% of" number.)

    I missed the part where they're going to borrow to get the $83k. In that case, you're better off with the bank's original calculation of $467k and just have 1 loan. If you've got 2, I guarantee one will be at a much higher rate.

  • D Ahn
    3 years ago

    @amber, I interpret it differently.

    "...we could use that cash value towards our 20% down payment and they would put a lien on our land. Instead they are increasing the "purchase price" of our home to account for that 50,000"

    I've never done a new build, but a construction loan to mortgage conversion is essentially a refinance where they approve a certain LTV, in this case 80%. (In essence, resale homes have the LTV rule, which the down payment satisfies.) 80% of the $510K appraised value is $408K, leaving a cash down payment of $9K to pay off the construction loan of $417K. The $9K down payment would make the loan amount $408K. But they're wanting to write a loan for the artificially inflated $467K, then give him $50K "cash value" which he can then use to make a "down payment," in effect giving them extra commissions and benefitting whiskey nothing.

    They're using nonsense terms to try to confuse whiskey into taking out a bigger loan than he needs. What's a land "credit"? Who puts a lien on (just) the land with a house on it which already has a lien on it with the mortgage?

    Something is going on at the bank, or they wouldn't "argue all day" over it. I suspect they're trying to push it into jumbo territory (>$417K in most counties), or there's a significant commission increase above $450K, or they're trying to meet some high value loan quota.

  • amberm145
    3 years ago

    I agree, they're treating it as a construction mortgage rather than a new mortgage on an existing property. And because they're treating it as a construction mortgage, they aren't using the appraised value to get the LTV, they're using the lower construction cost number. They aren't loaning them $467k, they're treating that as the value of the house they can loan against. WB could then use the "cash value towards the 20%", meaning the 20% of $467k they are required to have in equity.

  • bry911
    3 years ago

    they're treating it as a construction mortgage rather than a new mortgage on an existing property.

    I don't see this distinction. I recently bought a home for $479,000 the appraisal came back at $539,000. My bank made me come up with $96,000 as down payment. I may have been able to rework the loan to pay slightly less down, but even if the house appraised for $1,000,000 my financing cap would remain $479,000. Unless you are getting a rehab loan, you can't borrow more than your cost from a conventional conforming mortgage.

  • amberm145
    3 years ago

    It's rare for a house to sell for significantly less than the appraised value. The appraisal is supposed to suggest what the house would sell for in the current market. A seller isn't going to let his house go for much less than professionals think they'd able to get for it. If anything, the bank appraiser is going to be a little conservative.

  • Pensacola PI
    3 years ago

    Good good stuff.

  • Sylvia King
    last year
    Were considering using our land equity as down payment as well. But reading all of these comments it’s makes me question... what is the benefit of it?
  • amberm145
    last year

    Silvia, if your equity in the land covers the 20% of the final value of the house the bank needs you to have invested, and the amount they loan you is enough to cover the cost to pay the builder, then the benefit is that you don't need to come up with more cash to finance your build. The problems occur when the cost to build the house (the money paid to the builder) is more than what the Increased value of the land will be. Or when the value of the land is less than 20% of the final value of the house.

    Even without meeting these conditions, you have to come up with less cash. OP was asked by the bank to come up with another $61k. Without having equity in the land, they would have had to pay the builder $70k (20% of what the bank was loaning them) plus a contingency. So even though they had $106k in equity, and that didn't cover their loan requirements, it still saved them over $9k.

  • Missi Smith
    last year

    I have read this entire thread and as soon as I think I finally "get it", I get confused again. I hope it's okay to ask my question here ....

    We purchased 35 acres with cash - paid $293,000. Planning on building a house on the land for approx. $500,000. Wanted to use the land as the downpayment towards the loan. What type of scenario would have me have to bring additional cash to the table? Hope this questions makes sense. :)

  • amberm145
    last year

    Missi, you need to borrow $500k to pay your builder. If the final value of your house is $793k or more (land value plus cost to build), the $500k you're borrowing works out to well under 80%, and other than maybe a few hundred dollars in loan fees, you're golden.

    If the final value of your house is $625k or less, then your $500k loan is going to be more than 80% of the value of the house. Then you're going to need to pay the difference between what the bank is willing to loan you, and what the builder wants to be paid.

    In between $625k and $793k, you're probably fine, but it depends on how much contingency then bank wants you to have.

  • bry911
    last year
    last modified: last year

    Were considering using our land equity as down payment as well. But reading all of these comments it’s makes me question... what is the benefit of it?

    Just to clear up a few things, you don't use your land's equity towards your house, and there is no way to not use it...

    In a home, equity is the difference between what you owe and what it is worth. It is a fair value modification of the basic accounting equation. Equity isn't separable from your house and/or loan. You don't really use your land's equity to build a house on it. It just springs into existence when you build a house. It is cheaper to build a house without having to buy the land than it would be buying both land and house. That savings is often large enough to "build" equity, which just means the value when complete is greater than the amount you paid to build it.

    In between $625k and $793k, you're probably fine, but it depends on how much contingency then bank wants you to have.

    Just to clear, contingencies are not really in the loan. Loans have headroom, which happens when the amount the bank will loan is greater than construction costs. If you have insufficient headroom the bank may ask you to prove available contingency funds. However, those funds are part of the loan approval process and not part of the loan. On the other hand shortfalls happen when the amount the bank will loan is less than construction costs and the bank will ask for additional money which is part of the loan, after which they may ask for proof of contingency funds.

  • jn3344
    last year

    I remember this thread. It was quite entertaining!

  • B Carey
    last year

    Also, if you are planning to use the full 35 acres, you need to ask the lender if they do in-house loans and will take a lien on the full 35 acres. When the lot/loan is secured by more than 10 acres, it is what is known as non-conforming. This means the bank can not sell the loan. (A bank can sell your loan, but still "service" the loan which means you can still come in and make your payments/inquiries through the original bank.)

  • jn3344
    last year

    Sometimes what they do is have you divide the parcel into two pieces.

  • Denita
    last year

    ^This. Only the piece containing the house can't be land locked.

  • Missi Smith
    last year
    Thanks All! We were planning on using Farm Credit Bureau. Getting all our items together but wanted to have some understanding before we bring everything in to their office.
  • D Ahn
    last year

    Clarification: you can't technically use equity in land as a down payment. You can only use post-construction equity (appraised value of the new house and land MINUS construction costs).


    If I recall, the OP thought the value of the land and home are separate, but the appraisal is for the lumped property. OP also confused equity in land as equal to cash; only cash is equivalent to cash, equity needs to be BORROWED against.

  • amberm145
    last year

    Just to clear up a few things, you don't use your land's equity towards your house, and there is no way to not use it...

    Not true (or at least not clearing anything up at all). You're required to have equity in the final house (usually at least 20%). This ensures you're going to keep making your payments so you don't get foreclosed on and lose that equity. When buying an existing house, you have to bring that 20% in cash as a down payment to create that equity. When building, if you already have equity in the land, and it's enough to cover the 20% of the final value of the house, then you don't need to bring cash. So you're using your land's equity on the new house. Another possibility is if your land is worth a lot more than the cost to build, you could, in theory, borrow against the land value and use that to pay the builder instead of taking a conventional construction loan. But that's a rare and unusual situation.

    You can also choose not to use your equity in lieu of a downpayment. Let's say you need $500k to pay your builder, and the final value of the house is enough that the bank is happy to loan you the full $500k. You can choose to bring another 20% in cash and only borrow $400k. You can't avoid having a lien on your land, though. Even if you aren't considering the equity you already have in the property, there's no way to put a lien on just the house and not the land.

  • bry911
    last year
    last modified: last year

    You're required to have equity in the final house (usually at least 20%). This ensures you're going to keep making your payments so you don't get foreclosed on and lose that equity.

    Everything you said there is wrong... You are not required to have equity in a house. I have purchased several rental properties with 100% financing. In fact, it is quite easy to get 95% financing on a home at a reasonable interest rate. However, there are usually very serious penalties for not having equity, and a lot of people would struggle to work esoteric financing deals.

    Equity, isn't some type of leverage to ensure that you are going to keep making your payments, the consequences of not making your payment does that. It simply mitigates the bank's loss if you can't make the payments. Banks typically use equity to set a cap on loan amount because there are rules on exposure to losses.

    When building, if you already have equity in the land, and it's enough to cover the 20% of the final value of the house, then you don't need to bring cash.

    Again, this is not correct. Equity in land doesn't mean you are going to have equity in the final house. It is completely possible to have $100,000 equity in your land, build a house that will be worth $500,000 at a marginal cost of $650,000. In fact, in low cost of living areas this happens quite often when homes are somewhat unconventional.

    For construction loans, the value of the finished house is determined by some type of appraisal on the finished property, the bank will loan some percentage of that (my bank does 90%), this is usually capped to prevent cash out of the deal at some percentage of build cost. This is usually expressed as a bank will loan a percentage of finished value up to a percentage of build cost, again my bank will do 90% of appraisal up to 100% of build cost.

    If you own the land AND that land increases the value of the home over the build cost, you can "use" that as your equity. However, you aren't really using it! Realistically, the bank just set a limit on what they will loan, and because you don't have to buy the land that is enough money to build the house.

    While cash and land are the two most common ways to establish equity, they are not the only ways. Many banks will allow any type of purchased equity as loan equity. For example, my bank will use purchased materials and appliances as equity towards the deal. Some banks will even allow sweat equity for certain qualified individuals with sufficient construction experience. Both of the previous two types of equity are more rare as they require a loan officer with portfolio loan approval power.

    -----------

    It really is better to stop thinking of it as using your land's equity to build a house and start thinking of it as the bank will loan you 80% of the final value up to 100% of the build cost.

  • amberm145
    last year

    The consequences of not making payments are greater the more equity you have in the property. If you had 0 equity, you could loose the house with no consequences (other than your credit worthiness and a place to live). But if you had 20% equity in it, you'd be more inclined to try to protect that equity (in addition to the loss of credit and accommodations).

    100% financing had a large contribution to the real estate bubble and collapse. Having had it in the past doesn't guarantee you can do it now, and wouldn't be common.

    I do agree with this statement:

    It really is better to stop thinking of it as using your land's equity to build a house and start thinking of it as the bank will loan you 80% of the final value up to 100% of the build cost.

    The only distinction is that it's the land equity (at the time of completion) that can be the 20% you need to make up the difference. Your attempts at clarity are having the exact opposite effect.

  • D Ahn
    last year

    @amberm, it's obvious you really get this subject. But it's kinda murky to a lot of people, and there are many ways to conceptualize it. It seems the biggest problem with folks who don't "get" it is they think of land and building as separate entities, each with its own dollar value. But as any real estate appraiser knows, the appraisal is on the entire property, and it often comes in far short of the cost of the land + the cost of building (in most markets, it costs more to build than to buy).

    I do like bry911's explanation for its brevity, and I believe it's technically accurate. While you make a good point re: equity as "skin in the game" to avoid default, it is not incompatible with bry911's. But it's post-construction equity that matters, not equity in land, probably because in case of default, it's much easier for the bank to sell a house than bare dirt.

  • bry911
    last year

    The consequences of not making payments are greater the more equity you have in the property. If you had 0 equity, you could loose the house with no consequences

    That is only correct for the non-recourse states (which are Alaska, Arizona, California, Hawaii, Minnesota, Montana, Nevada (late 2009 onward), North Carolina, North Dakota, Oklahoma, Oregon, and Washington) and only if you didn't do one of many financing options that turn a non-recourse loan into a recourse loan. In most states a build to perm loan would qualify as non-recourse but a build only loan that was refinanced to a perm loan would remove the non-recourse status.

    In recourse states the bank can foreclose and then send you a bill for the difference.

    But if you had 20% equity in it, you'd be more inclined to try to protect that equity

    People don't really think that way, if they did then they would sacrifice all negative equity investments. In fact, the exact opposite is true, people tend to make their house payments when they can make their house payments and tend not to make their house payments when they can't afford it, regardless of their equity positions.

    The most common reason people lose their home is lack of access to liquidity. Those who can afford to make their payments and choose not to are an incredibly small number. Typically, foreclosure is triggered by an unforeseen financial event, which removes liquidity and/or access to it. If lenders wanted to ensure that people made payments they would require additional contingency funds rather than down payment.

    100% financing had a large contribution to the real estate bubble and collapse.

    I apologize in advance for the rudeness of this statement, but as an Economics professor with a PhD in Accounting, I am just tired of people inventing reasons for the financial collapse. The financial collapse was caused by Credit Default Swaps (CDS's) inflating the demand for high yield Mortgage Backed Securities because it prevented the securities from properly adjusting yields because of the additional yields from CDS's. Essentially, it prevented the market from correctly pricing in risk. There are many other factors that worsened the effects such as the bubble, but they were not really the cause. Nor was 100% financing itself a real contribution other than the fact that the demand kept banks from properly pricing in risk.

    In reality there is nothing wrong with 100% financing, so long as the bank properly prices in the marginal cost of default. In fact, there is nothing wrong with 120% financing so long as the bank properly prices in the marginal cost of default. That is the way loans work, they have a risk, a cost in default, and an interest rate. So long as the interest rate is sufficient to cover the additional cost in default when spread across loan portfolios the bank is sufficiently protected.

  • D Ahn
    last year

    @bry911, you wouldn't happen to be a behavioral economist, would you? Some of your post suggests it. :) I've never been a fan of the "perfect competition" fantasy of classical free market economics.

    I'm NOT an economist, but I want to say in Amber's defense that subprime no-docs high-risk loans (maybe not only 100% financing) contributed to the collapse by feeding the mortgage-backed security beast, did they not?

  • amberm145
    last year

    D Ahn, I realize that for the most part, bry911 are in complete agreement. However, he keeps telling people they're wrong in a way that confuses even me, someone who gets it. I can just imagine how confusing it is to someone who doesn't get it. Now that I realize he's a professor, it makes total sense.

  • bry911
    last year
    last modified: last year

    you wouldn't happen to be a behavioral economist, would you?

    I study firm efficiency is project development. Not really a behaviorist.

    that subprime no-docs high-risk loans (maybe not only 100% financing) contributed to the collapse by feeding the mortgage-backed security beast, did they not?

    Uhmm... You just named several things that have nothing to do with 100% financing as if they did. Most financial collapses happen for the same reason, and the latest was no exception... bad information. More specifically most financial collapses happen when risk and rewards are misaligned, because investors do not appreciate the risk of their investment.

    However, he keeps telling people they're wrong in a way that confuses even me, someone who gets it. I can just imagine how confusing it is to someone who doesn't get it. Now that I realize he's a professor, it makes total sense.

    Often people have functional misunderstandings that work. I submit that it is only confusing because you are filtering it through your understanding.

    Equity is simply the value of an asset less what you owe on it. It has a very specific meaning and is often called net position.

    Equity can be converted into cash via equity loans, and while they change the equity in the property, they don't change the owner's total net position, as you have changed property equity into cash equity. This can also happen in reverse by paying off debt.

    Equity can also be created by work. For example, oil in the ground is valuable, but when you work to extract it, it becomes even more valuable. Likewise, land is valuable, when you work to put a house on it, it becomes more valuable. Your equity position in your land grows if the cost to build a house is less than the value it adds to your land. On the other hand your equity position shrinks if your cost to build a house is greater than the value it adds.

    Banks use different metrics to assess the risk of making a loan, and will establish a maximum loan to value. This essentially forces you into a certain equity position on your home. However, you aren't using equity, in fact, your are either growing your existing equity position or shrinking your existing equity position by building a house on land you already own.

    You may also choose to borrow less money, which grows your equity position in your land, however, you can't really choose to not use land equity, as it is not used anyway. The bank establishes the value of the house when complete and then establishes an amount they will loan on that. If that is sufficient to build a house, then you are golden... If not you have to pony up some cash.

  • B Carey
    last year

    If we stop thinking about how much equity we already have in our land, and instead use a simple calculation:

    Appraised Value of Final Property (which includes completed home on/and land...this is ONE figure, not two separate figures for land/house)

    Times .80

    Equals Maximum Loan Amount (including any outstanding loans on the lot)


    To figure out how much cash or alternative equity sources you need, use this calculation:

    Total Construction Cost

    Minus

    Maximum Loan Amount

    Equals

    Cash or additional equity needed.


    Oftentimes, a bank will take a lien against your current home for the cash/additional equity needed.