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The Construction Appraisal - What You Need to Know Before Your Loan Gets Denied

Jun 8, 2008
The appraisal is just as important to your construction loan qualification as your income, assets and credit. The appraisal for a home to be built is even more important than an appraisal for a home that already exists. For a construction loan, the appraiser will do what is called a "plans and specs appraisal," meaning they will examine the plans and specifications for the home to be built and compare it to existing homes in the immediate area that are similar.

An appraisal is an assessment by a licensed appraiser (an opinion, really) of the value of a particular home at a given time. The appraiser, who is licensed by the state, must follow certain rules regarding how an appraisal is conducted.

They must locate similar homes within a close proximity to your location (usually 1-3 miles) that are on similar size land. This is called finding "comparables," or "comps." A "comp" is not a "comp" if the home has not sold on the open market within the last six months. This can be stretched up to a year, but most lenders prefer six month old comps or less.

This means if you are building a 2000 square foot colonial style home on 1 acre, the appraiser must find at least three other roughly 2000 foot (usually within 15% of the size) homes on roughly 1 acre of land. If they cannot do this, there are often problems with establishing value. This could lead to a loan denial or to the lender making adjustments to the value (usually lower).

The best advice is to know the area you are building and not try to build a home that is way out of the ordinary for the area. We often see borrowers who want to build a home that is significantly larger and more expensive than the other homes in the area (called "overbuilding for the area"). They may be perfectly qualified as a borrower, but if the appraiser has problems establishing a legal appraised value, the loan could be denied.

Another issue often arises with large lots. If you find a 15 acre lot in an area of half-acre lots, you may run into problems with the appraisal. Lenders do not want to be stuck owning a property (if you were to default on the loan for some reason) that is out of the ordinary from the rest of the area. They need to be able to sell it quickly and may have trouble doing so if it is not typical for the area.

Here are some other common issues to consider: lot size, type of construction, and location of your intended home.

Most lenders will limit the size of the land on which you can build to 40 acres or less. As mentioned above, there must be comparable lots in the immediate area to justify the larger size. For example, your lender may be able to approve a loan for a home to be built on a 32 acre lot, but there must be other somewhat similar sized lots with somewhat similar sized homes available as comps. If the appraiser cannot find "comps" for this project, the chances are you will be denied the loan no matter how well qualified you are as a borrower.

The type of construction is also an important consideration. This is a common issue with log homes, but it can be problematic with any type of construction that is different than a regular "stick built" home. The appraiser must be able to locate "comps" for the type of construction you are building. This means, if you are building a log home, there must be other log home sales in the immediate area within the last 6 or so months that are similar size and on similar land. See the potential for problems?

Here's an example from an actual client who wanted to build a log home on land he already owned free and clear. His income, savings and credit were excellent. In all, he was a well qualified borrower. However, he wanted to build a log home, a very nice log home. He said there were several log homes in the immediate area, thinking there would be no trouble with the appraisal.

However, the appraiser reported there were no comps for over 60 miles! How could this be? The appraiser explained that none of the log homes in the immediate area had ever sold, as they were all built by the owners who still lived in them.

What's the lesson? A comp has to be a SALE of a similar type home, not just another nearby similar house. The second lesson is that many log homes are built as either retirement or vacation homes. The owners build them and never let go of them.

Ironically, this particular client said he could stand on his would-be front porch and see four log homes. But, none of them had sold, meaning they could not be considered comps for the appraisal. Fortunately, in the end, due to his impeccable qualifications and an endless amount of negotiating with the head of the construction lending department, he was able to build his log home without a log home comp. But, don't count on this happening again.

The other area of concern for appraisals is the location of the property. Your lot will be considered to be either in an urban, suburban or rural setting. This will determine how far away the comps can be. Typically, in an urban setting, comps must be a half mile or less from the subject. This may be stretched to a mile in some cases. For suburban properties, one to three miles is the maximum distance allowed in most cases. For rural properties, the comps should ideally be no more than five to ten miles away.

There are exceptions to these rules, but you should not count on an exception being made. It is best to understand how an appraisal interacts with your loan application and do as much research as you can before you make any financial commitments. Often, if you find a lot and house plan you like, you can hire a local appraiser on your own to just "run comps" for your proposed home. Expect to pay for this service, as appraisers are professionals and should be properly compensated for their time and expertise.

But, this could be the best money you ever spend if there are any questions as to whether a good appraisal can be obtained for your proposed home. It is better to know early instead of spending time and money on plans, deposits, the full appraisal and any other expenses you may incur.
About the Author
Chris Esposito provides owner-builder construction financing nationwide through his Owner Builder 101 program. Visit www.OwnerBuilder101.com to get all the information you need to be a successful owner-builder, saving tens of thousands on your next home. Or call Owner Builder 101 at (877) 876-3688.
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