The Mortgage Professor: Loans hard to find for land with multiple structures
Recent questions in my mailbox:
QUESTION: We have a beautiful home with 5 acres, and there is a second smaller structure on the property. We have been trying to sell since 2008 with no bites until recently, when a buyer appeared. We lost the sale, however, because the bank refused to finance two structures on one parcel. ... Any suggestions?
ANSWER: Split your parcel into two parcels, each with a structure, and sell them separately.
Two structures on one parcel is a big problem for the owner trying to sell it because potential buyers will have difficulties getting financed. If the second structure is a habitable unit, the question arises of whether the buyer will rent it out. Under the rules, such a buyer is an investor rather than a permanent occupant. Investors are subject to more strict underwriting rules than permanent occupants, and pay more for their mortgages.
If the second structure is some kind of an appendage to the main house, such as a barn or recreation facility, a potential purchaser will face a different problem. An appraisal of the property will be based on the assumption that the second structure has no value, which means that the loan amount will be smaller and the required down payment will be larger.
Home appraisals are based primarily on "comparables." These are recent sale prices of homes that are similar to the property being valued. But a parcel with two structures will not have any comparables, forcing the appraiser to ignore the second structure. The appraisal will therefore undervalue the property as a whole.
The problem posed by two structures on one parcel will seldom arise in connection with very expensive homes, because the margin of error in appraisals is very large even without the complication posed by multiple structures, and eligible buyers will not need much if any financing. But the lower the price range within which the property falls, the more are potential buyers dependent on financing a major portion of the price, and the greater is the penalty posed by multiple structures.
Q: I applied to refinance my jumbo mortgage and was almost through the process when the loan officer asked if there had been any remodeling done. I am in the process of replacing a bay window and am just now applying for the required town building permit, which can take a couple of months. Will that hold up the refinance?
A: It might. On the face of it, the lender should not be concerned about improvements in the property that increase its value, since that makes the loan a safer investment. But in fact the lender is concerned that in the process of making an "improvement," the owner may have violated local building codes, which could make the property unsalable in the future. This danger is greatest when the owner does the work himself and doesn't want to be bothered with (or doesn't know about) the local building codes.
If a loan officer asks about improvements, it is because he is following the instructions of the underwriter, who wants to make sure that work on the house has been done legally and is in compliance with building codes. The underwriter will want this verified by the local government entity that enforces the codes.
Since you have improvements in process, don't be surprised if the loan officer tells you to come back after they have been completed and document that they are in compliance with the codes.
Bottom line: Borrowers should not refinance and remodel at the same time.
Q: I own a home with a current market value of $350,000. I have a mortgage balance of $150,000, but I am no longer able to make the payments. If the lender forecloses and sells the property for $350,000, is the lender obliged to return the net equity of $200,000 to me?
A: Yes, except that the net equity would be much smaller than $200,000. The lender will probably sell for a knock-down price to get it off their books fast, and they will bill you for their foreclosure expenses, unpaid interest and whatever else the law allows.
Waiting in the house while the foreclosure mills grind does have the advantage that you can live rent-free and your need to find alternative housing is deferred, but it will cost you a major portion of your equity, and it will also torpedo your credit.
Bottom line: Retain your equity and your credit by selling the house and paying off the mortgage.
Q: My wife and I have found our dream house, and we can afford it, but we are having trouble making the decision. ... Do you know of a good decision-making process we can use?
A: Use the same process you used when you decided to get married. The decisions are similar in that, after you have analyzed all the pros and cons, you feel the right decision in your gut.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
(c)2014 Jack Guttentag
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