This is part two of a three part blog that explains several things you need to know about your modular home payment. Part two explains the difference between a COD modular payment and an “assignment of funds” modular payment.
Why Modular Home and Stick Home Payment Schedules Are So Different
When customers construct a stick-built home, they usually do not wait until their home is framed, insulated, drywalled, wired, plumbed, and finished with cabinetry, doors, moldings, and flooring before paying their builder. But that is likely what you will do when you build a modular home. Your dealer will probably obtain a 10-percent deposit from you, but not receive the balance until he has built and delivered your home. As you can imagine, the many thousands of dollars required to manufacture a home makes the final modular payment a very significant event for the dealer and his manufacturer, who must also wait until you pay your dealer.
Although most dealers and manufacturers require a 10-percent deposit before they will build your home, some dealers require a deposit of 25 percent or more for a true custom design, since it could be more difficult to sell than a standard plan should you not honor your contract. Many dealers also require an additional deposit when you are paying with private funds, as will be explained below.
A few modular dealers will give you priority scheduling or offer a small discount if you prepay for the home. But you will only want to take advantage of that if you are sure the company is financially sound. Normally, you would pay off the balance after the home is delivered to your site or set on the foundation.
Why the Final Modular Payment Is So Important to the Manufacturer
When a dealer and manufacturer build a home after having received only a small percentage of the purchase price, they are taking a risk. After all, the manufacturer must pay its vendors, factory production crew, and delivery crew. The dealer must in turn pay the manufacturer, whether or not you pay him, since he will have a contract with the manufacturer.
When a customer does not pay for a home, the dealer and manufacturer are compelled to sell it to someone else, usually at a substantial discount. That is why the dealer and his manufacturer will be very concerned about receiving their modular payment in full for the balance owed on a home as soon as possible after they build it. That is also why all manufacturers prefer to be paid cash on delivery (COD), and many insist on it. Most lenders, however, prefer to make the final modular payment after the home is set on the foundation.
Why the Manufacturer Prefers A COD Final Modular Payment
The manufacturer wants to be paid COD because once the modules are attached to the foundation they are legally no longer considered personal property, which is what they are when they are sitting on their carriers. If you do not pay the dealer after the modules are on the foundation, the manufacturer cannot remove them and take them back to the factory, something the laws for personal property allow with a car. The modules are now real estate, and that difference gives the homeowner a great deal of protection against creditors. The dealer and manufacturer would need to get a court order to remove the modules, and this could take months and many thousands of dollars.
Why the Lender Prefers an Assignment of Funds Final Modular Payment
Most lenders take an opposing point of view. They do not want to disburse funds from a construction loan to pay for the modules until they have been set on the foundation. Their view is that they are lending money for real estate, not personal property resting on a carrier. Many lenders, dealers, and manufacturers have reconciled their conflicting demands by relying on what is known as an “assignment of funds” procedure, in which an authorized official of the lender writes a letter to the dealer or manufacturer committing to pay one of them an agreed upon sum after the modules are set on the foundation and inspected by a representative of the lender. This protects the lender and its customer by making the modular payment contingent on an inspection that the home is correct and properly set. The dealer and manufacturer in turn get the security they need by receiving a written commitment from the lender to pay the dealer or the manufacturer once the inspection is complete. In effect, the dealer and manufacturer are relying on the lender’s obligation to make good on its assignment rather than the customer’s obligation to honor their contract. When done properly, the letter assigns sufficient funds from the customer’s construction loan, usually equal to the balance owed by the customer for the modules, to the dealer or manufacturer and promises to make the modular payment either by wire transfer or with a bank or certified check.
For more information about the difference between a COD modular payment and an “assignment of funds” modular payment, see Financing a Modular Home in my book The Modular Home.
This is part one of a three part blog that explains several things you need to know about your modular home payment. Part one explains why you need a construction loan if you are using a lender to finance the construction.
Financing Construction of a Modular Home
To build a modular home you will need to pay the dealer for the modules and the general contractor for his services. If you do not own a building lot, you will need to purchase it as well. There are three typical sources of these funds. The first is private funds, such as personal savings, an equity loan on another property, the sale of personal assets, or a family loan. The second is a construction loan from a lending institution, usually a bank, credit union, or mortgage company. The third source is the modular dealer or modular general contractor.
Payment for an Existing Home
There is one very significant difference between paying for an existing home and paying to build a new home – whether it’s built with modules, logs, panels, or “sticks”. When you buy an existing home you pay the seller in full before you take possession of the home. If you use a loan to pay for the existing home, you secure the funds with a mortgage.
Payment for Building a New Home
When you build a home, you make periodic payments as work is completed. You cannot wait until the home is completely finished to pay the modular dealer and modular general contractor in full because they need funds to pay for materials and labor as the project progresses.
Modular Home Construction Loan
When you use a lender to build a home, they provide these series of payments as work is completed through a “construction loan”. This is a short-term loan usually of four- to twelve-months’ duration. Once the local building inspector issues a certificate of occupancy and the lender agrees that the home is essentially complete, the modular lender pays off the construction loan and issues you a mortgage. Note that the construction loan process protects you and your lender should something prevent the builder, in this case the modular dealer and modular general contractor, from completing the home. Receiving compensation as the job progresses also protects the modular dealer and GC should something prevent you from paying for the finished home.
Although you will still need to obtain a mortgage, you will not need to secure a construction loan if the modular dealer or modular general contractor finances the construction. They are more likely to do this if the modular dealer is completing the GC work, but especially if the dealer or GC own the land. Ownership of the land and responsibility for the construction tasks gives them greater control of the project and reduces their risk should you decide not to purchase the finished home. When you purchase a modular home that is funded in full by the dealer or GC, you are in a sense purchasing an already existing home. In fact, you will not take ownership of it until you pay them when they are done. That is why they are likely to require you to provide evidence that you have secured a mortgage or have the personal funds to pay for the finished home.
For more information about paying for a modular home with a construction loan, see Financing a Modular Home in my book The Modular Home. For a detailed schedule of when each of these tasks must be completed, see Building a Modular Home on Schedule also in my book.
Several of my posts have echoed the theme of keeping a contingency fund to protect yourself against unbudgeted expenses. But it is so important that I’m going to elaborate.
The Unforeseeable and Cost Overruns
No matter how vigilant you are, building a new home always produces a few surprises. Unfortunately, these surprises often result in additional expenses. When they appear you might be tempted to blame someone, but it is not possible for everyone to foresee everything. For example, after the general contractor (GC) begins excavating for the foundation, he might discover that your property contains an underground spring exactly where you want to put your home. To prevent a wet basement, you will need to take some costly and unbudgeted precautions. Unless you had the GC dig a test hole in this area before he finalized his contract with you, neither of you could be expected to have anticipated the problem.
Mistakes and Cost Overruns
There are other sources of cost overruns than the unforeseeable. Failing to read your building specifications closely is a common source. It can cause your home to be built to specifications you do not want and to be missing features you expected to receive. Correcting either type of mistake will add to your expenses. Your contract may include allowances for some preconstruction tasks that are insufficient to cover the actual costs when they are later determined. This could include, for example, completing a property survey or paying for the utility hookup or building permit. If you discover you need to complete these tasks after closing on the construction loan, the dealer and GC will need to stop what they are doing until you come up with the money to complete the tasks.
Other Sources of Cost Overruns
You may be forced to absorb additional costs if you change your mind and, for example, decide you want hardwood flooring instead of carpet. In other cases, a town official could be responsible for your additional costs. For example, the building inspector may require your GC to complete some costly additional work that is not included in his contract because it is not mandated by the building code. You may also incur additional financing costs should the project be delayed by inclement weather, material shortages, or subcontractor scheduling conflicts. Your GC may or may not charge you for these problems, but your lender will almost certainly require you to pay additional interest if you are financing your home with a construction loan.
Plan for Surprises by Creating a Contingency Fund
The complexity of building a home presents so many opportunities for mistakes that it is best to simply plan for them. Although you cannot budget specifically for what you cannot foresee, you can create a contingency fund to protect yourself against unbudgeted expenses. For a modular home, 3 percent of your modular and GC expenses will probably suffice. You can keep a reserve of cash for the contingency fund or ask your lender to include a contingency fund as a budgeted line item in the construction costs. Some lenders will do this even if you do not ask, and even if you do not want them to; many lenders only require this for stick-built homes, since they are historically more prone to sizable cost overruns.
How to Create a Contingency Fund
If your total construction costs already bring you to the maximum amount the lender will give you plus your down payment, the only way you will be able to create the contingency fund is to eliminate other expenses. The best way to handle this situation is to eliminate something you can readily add later. If you get lucky and avoid drawing from the contingency fund during the project, you can spend the money on the eliminated item. If you are forced to tap into the contingency fund, you will spend money you undoubtedly hoped to save, but you will not be forced to come up with money you do not have.
For more information about paying for creating a contingency fund for financing your modular home, see Financing a Modular Home in my book The Modular Home.
Loan Prequalification
When you begin shopping for a construction loan, ask one or two lenders to prequalify you for a loan. This will give you a good idea of the maximum amount you can borrow, which will help you develop a realistic budget. Prequalification, however, is not a promise of a loan. To prequalify, you must answer a few questions about your income, assets, liabilities, and credit history. Assuming the information you give is accurate and no other issues surface when you formally apply for the loan at a later date, you will probably be approved. Should the lender’s review of your formal application turn up different information, however, the lender may deny the loan approval or offer to lend you less money.
Loan Preapproval
As soon as you have selected a lender, consider applying for preapproval of your construction loan. Preapproval takes prequalification one step further and results in a written commitment by the lender. Some lenders charge for this service, some do not. Preapproval comes with a list of conditions you will need to meet for full approval, which usually includes a satisfactory appraisal of your completed home and the requirement that your personal financial situation does not change. If you are preapproved before selecting a modular dealer and general contractor, you will be able to move ahead with building your home more quickly, since the lender can immediately begin to review your construction documents after you make your selections. To secure final approval, the lender must receive written documentation of your income, assets, and liabilities. It will also need to obtain your credit rating from an approved agency. In addition, it will want copies of signed contracts with your modular dealer and the GC and, if you are buying a building lot, the purchase and sales agreement with the land seller. Finally, it must receive an appraisal on your home showing that it is worth what you are paying.
For more information about obtaining a prequalification or preapproval for a construction loan, see Financing a Modular Home in my book The Modular Home.
A written offer to purchase for a building lot should include language that allows you to build the home you want, where you want it, and for a price acceptable to you. You should have your attorney include all contingencies that will provide the protection you need. If you are unable to meet one of these contingencies, the agreement should allow you to withdraw your offer to purchase for a building lot and receive a full deposit refund.
If the seller rejects a proposed contingency, he might accept a less demanding one. For example, the seller might not agree to a contingency that allows you to first obtain a building permit, since this might take too much time. But he might agree to make the offer contingent on the property passing a percolation test or being approved by a wetlands board. If your research indicates that these are the only potential obstacles to obtaining a permit, your attorney might advise you to submit the offer to purchase for a building lot with these contingencies in place.
These contingencies will only help you, however, if you take the appropriate actions they allow you to do. For example, when shopping for a dealer and GC, you will need to make sure their estimates are for the home you want and built to the correct specifications. This means that the dealer and GC must do their homework, as well. For example, if the property has access to town water and sewer at, the GC must determine if the hookups can be made inexpensively or require expensive excavation into the street.
Contingencies to Include in an Offer to Purchase for a Building Lot
- The buyers can secure sufficient financing for the home they want to build
- The buyers receive an appraisal at full purchase price by a licensed appraiser selected by either the buyers or their lender
- The buyers are satisfied with their review of the deed
- The buyers are satisfied with their review of any easements, deed restrictions, covenants, flood plain designations, or wetland restrictions
- The buyers are satisfied with their review of the applicable zoning regulations
- The property has a registered survey, the boundary stakes are in place, and the boundaries are as represented by the seller
- The buyers are satisfied with their review of the perc test and septic design
- The buyers are satisfied with their review of any required flood insurance
- The buyers are satisfied with their review of any water test, whether required for a permit or completed at the buyers’ discretion
- The buyers are satisfied with their review of the radon test and any required remediation
- The buyers can obtain a building permit for the home they want to build
- The buyers can dig some exploratory holes on the property to assess and approve subsoil conditions and are satisfied with their findings
- The buyers obtain an acceptable written cost estimate from a builder of their choice to build the home they want to build
For more information about making an offer to purchase for a building lot, see Finding and Preparing a Building Lot for a Modular Home and Financing a Modular Home in my book The Modular Home.
