When Six of One is not a Half Dozen of the Other

One of the most stressful moments of our construction loan process came at the last minute when the bank told us they had made a minor oversight. Their policies dictated that they lower our loan amount substantially. We were out of time and had no good options.

A note about numbers:

Going forward, you will see occasional real-world financial figures from the project. I’m normally a fiscally private person, but I feel it is important to have a frank discussion about dollars in this blog for a couple of reasons:  First, if you know me, you can easily look up the biggest of these numbers in Zillow or Redfin. The moderately curious could fill in the details with little effort. Second, if you are reading this, it’s almost certainly because you want an honest description of the process and the numbers are a substantial consideration whether you’re building a cabin in the woods or a house by the park.

The Problem

Our loan broker told us several times that the loan amount would be the lesser of the appraised value or cost. In our case, our projected appraisal was $620K–comfortably over our actual cost of $300K for the lot and $278K for construction. Our loan broker submitted a $462K loan based on the lower cost figures at based on 80% LTV.

The snag came during the 7th week of closing near the end of our first extension when the underwriting department noted that the lot itself appraised for $275K and the planned structure accounted for the rest of the valuation. They insisted on re-calculation of the loan with the lower $275K figure for the lot. The final loan would be $20K less than anticipated, and we had only hours to go before the extension was up.

I argued for sanity or flexibility, but there was none to be found. From my perspective, they would only write a loan for 71% of their own appraised value. Unfortunately, the bank doesn’t take the long view on these things.  They assume we may as well default on our first payment so they don’t want to have paid out more than 80% on the land itself.  In appraisals, it’s not just the final value but how you get there that counts.

The Options

Fight it

At nearly two months into the process, this didn’t seem like the right time to draw out the process by another several weeks. Once we went beyond our initial closing period, the seller could easily choose to walk away and sell to the next buyer who had cash.  We would lose everything we spent so far on the process.  Had we learned about this when our appraisal came back a month and a half ago, we most likely would have pursued this option, but not now.

Push back on the seller

Maybe a buyer could have gotten away with lowering their offer four years ago. In today’s market, flat and dry lots are exceedingly rare gems. Developers are snapping properties like this one up with cash offers overnight. Frankly, I’m still surprised our seller didn’t get a better offer and waltz off into the sunset with a big fat money order.

Pay PMI

We could pay a non-refundable monthly fee to make the problem go away, but I loathe private mortgage insurance (PMI). Most banks, Banner included, have rules that require the monthly fee for a minimum of two years. Unlike normal loan payments, the PMI starts immediately and not when construction completes.  PMI would be a minimum $6,600 cost out the window. For people close to the threshold, PMI amounts to a penalty fee tacked on top of an already jacked up interest rate because they couldn’t make the 80% LTV mark. It’s like turning the hose on a person who is doing their best by barely treading water.

Cough up the difference

If the bank is lending less and the total price isn’t coming down, the only other way to make ends meet is to pony up the difference. Certainly this is no small feat for a family with two young children. We would have to dig really deep and make sacrifices we weren’t prepared to make–if it were something we were even capable of.

Walk away

I could see the deal crumbling as the loan agent described the situation. Regardless of our options, there was a dark hour where I felt like all was lost. Not only were we financially wrapped up in this deal, we were emotionally bound to it as well. In some ways, my own identity had become bound to the address.

It is advisable to remain pragmatic and unattached until the deal is done, but it is nearly impossible not to get wrapped up when it comes to your home, especially after all these months of working toward that point.

The Solution

In the end, we swallowed hard and made the tough call to stick with it by paying the extra cash. We went all in knowing that we’re essentially buying extra equity and lower monthly payments. Now more than ever we believe this project will yield considerably more value than the sum of its parts.

The Lessons

First and foremost, make sure you have experienced and competent folks on your team. As mentioned previously, if I had this to do over again, I’d probably have a real estate attorney instead of a Realtor.

Second, understand that not all appraisals are the same. Know the details and what they mean. Get clarification from your lender as to what exactly the maximum loan criteria are.

Finally, get yourself a copy of the appraisal ASAP. Our lender indicated several times that their policy was not to share the appraisal with the buyer until three days before closing. However, the appraisal was always my single biggest concern with this whole loan process, so I made sure to finagle a copy.  Unfortunately, I still managed to gloss over the critical figure a few pages into the 22-sheet report.

Photo credit: kimba77