What Direction Should I Take?

de51 · Joined: 06 Aug 2005 Posts: 2

My in-laws will be giving my wife and I two acres of prime land in an expensive development. So this land will be owned by us free and clear. The land itself would sell for about $400K. We want to build a nice home which will cost about $300K to build. So when we get done the house and land would probably sell for around $750K or more (We're not selling but this would be its market value). This will be the first house my wife and I have ever owned. I make about $50K and have a FICO of 625. My wife is a stay at home mom. My income should be increasing pretty well over the next couple of years. What kind of loan should I be looking to get to build a house? Would an interest only loan be a good idea? How much of a down payment will I need, or will the land itself be good collateral? Thanks for any help!

Haplo · Joined: 20 Jan 2005 Posts: 2406 Location: Springfield, IL

Lets look at some numbers. Assuming that you have the capability to go on a conventional loan, you're going to be pretty high on payment at 350,000. Somewhere around $2,100 if you went with a 30 year fixed loan. If you knock that down to say, a 5 year arm interest only, that'll save you a few hundred dollars a month. Add in your taxes on a $750,000 property and you're going to be well over 50% of your gross income ($4,166.66 per your numbers) and that's not including any other debt that you have.)

Find out how much the taxes are roughly in your area. Overall it would be best if you keep your housing expenses to below 1/3 of your income. ($1388.) This would leave you in the range of about $200,000. Even if your income is likely to increase over the next few years by a decent amount, try and consider that you still have to *get* to those years. A short term adjustable may be fine for you until you get there to help lower payments, but putting yourself at 50% of your gross income without considering any other debt is just asking yourself to fail.

Haplo · Joined: 20 Jan 2005 Posts: 2406 Location: Springfield, IL

Oh, and no matter what anyone says, don't use a stated program so that you can list that you have more income than you actually have. That is fraud. Stated programs aren't available to 'give you a boost to your income because of your credit', they are available for hard to prove income for qualified buyers.

m2c · Joined: 03 Aug 2005 Posts: 764

As you know your FICO isn’t going to blow anyone’s socks off but, all other things being equal, should be adequate. Is this FICO a mortgage model FICO? “Other” FICOs should be close but you’re near a critical “break point”. You may be located in one of the “geographic dog” areas with below average FICOs. It wouldn’t hurt to go to http://www.nationalscoreindex.com/ so that you know what underwriters are used to from your market. Review your “reason codes” – these should be listed under the report if you ran it yourself or in the score disclosure notice given to you if a mortgage broker ran the report. Improving your score might be important since your debt ratio is going to be high. Liquid assets would be very helpful and you do indicate you have additional funds for downpayment. The land value should be adequate for the downpayment but there’s a balancing act between what you feel comfortable with in your monthly budget, possibly paying down credit card debt to improve FICO, etc. Rate will likely increase if you borrow more than the conforming loan limit -- $359,650 in most areas of the country.

Not to be a traitor to my industry but you should probably speak with a portfolio bank or mortgage banker who will manually underwrite. “Career path” should be an important factor and it’s hard for a computer to factor this in. Personally I would not want to have a construction loan “spun off” immediately. Change orders and other issues are likely to arise in a construction loan and I’d rather talk face-to-face rather than via phone to some anonymous servicer across the continent. For a “standard” existing home purchase, this long-distance issue is not a bid factor …. at least until the servicing on your loan has been sold for the 10th time in 5 years.

How appropriate is the building to land value ratio for your market? Nothing wrong with building the least expensive house in the neighbor but you may wish to design the home with this in mind. You will sell eventually and with this acreage and land value, a potential buyer may want more square footage. Design so that an addition is a logical and easy solution.

Single close construction-perm loan should fill the bill. IO hybrid would give you a lower rate and, given your anticipate future income increases, gives you enough “control” to mitigate the future rate risk you’d be assuming. An initial fixed rate term of 5 years or less gives you a 2-2-5. Above 5 years you are looking at a potential increase in rate in the first adjustable year of 5 percentage points. Make sure the clock starts ticking and the initial rate applies during the construction period. For example, Wells Fargo charges based on prime rate (currently 6.25% and soon to be 6.50%) during construction.

As a general rule I would sell my worst enemy an option ARM but it could fit here – trade off eating away your equity for a low monthly payment with payment caps … at least for awhile. Make sure you understand this type of loan and have loan officer run projections for 15 or 20 years at “worst case” and “probably case”. Yes Virginia, there is a reason why they want to show you only a few years.

You are very fortunate to be in an instant equity position. BUT you need to consider monthly expenses at your current income level. You may well want to wait a bit until your income increase materialize. Remember it does take some time to design a home.

de51 · Joined: 06 Aug 2005 Posts: 2

Thanks for the advice so far. The national score index for my area is 689.
So I guess I need to work on credit score improvement. I should be at $75K a year from now and $100K 2 years from now. It will most likely take a year from now before the house would be done, but obviously I need the mortgage to get it started. My in-laws may possibly co-sign. They are well established. What would be the best option in this case? Just the traditional mortgage?

m2c · Joined: 03 Aug 2005 Posts: 764

I think you're starting to see the light!

Before tieing up your inlaws on a co-sign discuss the company's policy on partial release of mortgagors. You don't want to have your inlaws credit tied up for years and years. This does restrict your choice of funds sources to someone who intends to retain servicing on your mortgage -- a porfolio lender or a "true" mortgage banker.

Might also consider assignment of a CD from your inlaws as additional security in lieu of cosigning.

Haplo · Joined: 20 Jan 2005 Posts: 2406 Location: Springfield, IL

That's a pretty significant increase in pay!!

m2c's got some pretty solid words for you there. You may not actually need a co-borrower for your loan, it all depends. You'll want to review your credit and find out what it's going to take to get it from a 620 to a 680+. Right now you may be ok for a conventional, but it might be at A- pricing (so slightly higher than standard rates.) If it's going to take a year, you'll find yourself in a better position financially and you'll have time to work on getting that stuff resolved (most likely you just need to pay off/down your credit card debt.)

Also keep in mind that some lenders lock up to a year on certain programs, if you are worried about rising rates during the construction process.