Pitfalls to Avoid When Considering Church Construction Loans
“Go and tell my servant David, ‘Thus says the Lord: Would you build me a house to dwell in?”
So you’ve decided to build a new church structure–maybe a chapel or a gymnasium or a family center or a community building. This is a righteous desire: you’ve seen a need and you want to fill it, you want to help your congregation spiritually and physically. You want a better opportunity to further spread the Word and you know that building a church structure will bring more people to the gospel.
But there are many things to consider when building a church structure. It’s not as simple as getting a loan for a home and then paying a construction company to build it for you. Churches have very specific and specialized needs that must be addressed before work can begin on digging the foundation.
Some of the Pitfalls to Avoid When Considering Church Construction Loans.
Let’s face it: we’re in an economic downturn, and during any downturn donations are going to be harder to come by. The church’s income is going to be affected and just raising the down payment is going to be a struggle, let alone convincing the lender that you are ready to be able to take on steady repayments with interest.
And it’s more than just the economy (though the economy is bad enough already) but church attendance is down across the board. It’s getting harder lately to fill the seats. The recent pandemic, which has shut down many churches across the country, has had a serious financial impact on the church, but there are whisperings that less church attendance is going to be the new normal. People who have been living without church attendance for months might be less prone to coming back once the doors are reopened and social distancing is a thing of the past. It won’t hurt your die-hard members of your congregation, but it may seriously affect the younger generations (who were already dropping in numbers) and a lender is going to look at those younger generations as the future of the church’s income. The baby boomers who are currently the biggest donors to church will continue to age, and the income of the church is going to fall to Generation X and the Millenials. Can you get them in the door and keep them donating?
It’s definitely possible. There are a lot of churches who have been doing a good job of outreach to the younger generations, but when you go in to apply for a loan to your lender, you’re going to need to be able to convince them that ten years from now you’ll still be able to make payments on your loan.
When you’re running your church, depending on its size the pastor may be the jack-of-all-trades who handles every aspect of the church’s temporal affairs, including bookkeeping. Or even if you have a bookkeeper, it might be a retired bookkeeper who’s doing it as volunteer work as part of helping out the congregation. You might have lay people who collect donations every week and who record the donations and make the bank deposit. And you may have very good financial safeguards in place to make sure that everything follows best practices and keep it all above-board. That’s great, and you and your volunteers are to be commended.
But when it comes to bookkeeping–and especially taxes–there’s something that banks look for, and it’s for real CPAs. Quickbooks and TurboTax won’t cut it when you’re applying for a million-dollar loan. You need to have a CPA going over all of your documents and preparing financial statements to give to the lender–and this doesn’t need to replace your volunteer bookkeepers, it just needs to happen in conjunction with them. And if you have a CPA who happens to be in the congregation, then that’s great–get them to help! But if you don’t, then you need to invest the money into getting someone to prepare your financial statement professionally.
Too Much Debt
We all know that we should stay out of debt as much as we can, and expanding a church (or building a new one from scratch) is a big endeavor that costs a lot of money. As Proverbs says “The rich ruleth over the poor, and the borrower is servant to the lender.” You don’t want to be a servant to the lender, or ruled over by the rich. So you need to manage your debt.
A good tool to use (and one that your lender will definitely look at) is your Debt Coverage Ratio. The goal of this is to have a ratio of at least 1:1, meaning that you have a dollar to pay for every dollar you owe your lender. This can be calculated by taking the net income from your Income and Expense Statement (preferably prepared by a CPA, as mentioned above) then adding back in depreciation, interest, amortization costs, rental expenses, and other costs. The higher the number, the greater your ability to pay back the loan. Generally, lenders like to see that you have a Debt Coverage Ratio of 1.25:1.
Ultimately, the point of all of this is to make sure you’re not borrowing money that you’re unable to repay. You don’t want to dedicate all of your future income to making payments on your own and neglect the temporal needs of your poor and needy.
Lack of Contingency
Another pitfall is the lack of contingency built into a project. This refers to the money set aside to deal with unforeseen problems that may arise during the building process. There is no single number that can be given for how big this contingency money needs to be as it varies from project to project, but there are almost always contingency costs when constructing any sizable building. They might be because of damaged materials, unforeseen complications arising during a remodel (like finding a plumbing issue you weren’t expecting, or needing to install a beam over a wall you didn’t know was load-bearing), or they might be weather problems that slow the construction process.
These problems are there in every construction project, so it’s essentially to have a proper contingency set aside to deal with them when they come up.
And you might think that once your loan money is in the bank then you’re free and clear, but that’s not the way that these loans work: lenders will monitor the construction process and if they ever learn that the cost to finish the project will be more money than the church’s contingency funds and the amount of the loan, they may stop disbursement of funds until the financial discrepancy is resolved.
Therefore, a lender will typically require that a church have a contingency in the bank (and be able to verify the financial records to prove it). Typically, this is around ten percent of the loan. This contingency money will be determined and agreed upon at the time of the lending, and having money in the bank will make you more likely to get a loan.
Errors in Estimate vs. Bid
When you start a construction project, you complete the plans (which, for large projects, is done before you get the loan) and then seek bids to see how expensive it will be to build your new church building. But the quirky thing about construction is that a contractor may make an estimate–say $400,000–but then when they make the bid it is significantly more than the estimate–maybe $475,000. If a church secures a loan for the amount that was estimated, but then faces a higher bid, they may lose the funding entirely.
A potential pitfall, however, is the “cost plus” contract, which is a bid that has wiggle room to expand as much as ten percent if the project ends up costing more than expected. Though this may seem like a solution to the estimate/bid issue, it actually ends up incentivizing the builder to not stay under their bid amount, leaving the church on the hook for the extra expense.
An alternate plan is the GMP Contract, or Guaranteed Max Price. With this plan, the builder has a cap at which they can’t charge anymore. This gives the church a cushion.
Not Knowing Source and Use
These are terms that lenders use when talking about building projects; “source” merely means the source of the funding, and “use” is the cost of the project. This may seem like a basic concept–and it is–but you’d be surprised at how often it trips up owners who are building a new project. You simply want to make sure that your source covers the entire use, so you have to plan your project to stay within that amount.
The source comes from three different places: the money you have in the bank, the money you can raise through fundraising, and the money you borrow. The biggest place where this causes a problem in church building projects is when you don’t do enough fundraising before the project starts. Often, people are motivated to donate to a project when they see shovels in the dirt, rather than donating to a future project that is harder to picture. But before the construction starts is when you need to know your sources the most. You don’t know how much to borrow unless you know how much you have, and you can’t do all the pre-loan work, such as getting designs and plans until you can afford to pay for them.
Not Knowing the Value of Your Property
One of the pitfalls to avoid when considering church construction loans is not even knowing the value of the property you own. Land and building prices are constantly changing, but very often when we’re about to start a new construction project we overestimate the value of our property. This is especially true if you did any building on your church facilities prior to the housing bubble in 2008. If you refinanced your mortgage during the boom (say, in 2005-2007, when everything was valued much higher) then there’s a possibility that your property now could be worth 20-30% less than it was then. Hopefully this doesn’t put you upside down in your building, but at the very least it means that you’re working your way out of a bad financial situation.
The reason you need to know this is that if you’re applying for a loan and using the equity in your church as collateral against the loan you may be in for an unpleasant surprise when it’s appraised. Because of this, you’ll want to get it appraised early in the process while you’re still raising money for the project, because it just may be that you won’t qualify for as much of a loan as you were hoping for and you may need to rely more on your cash reserves and fundraising opportunities.
Nonprofessional Construction Help
Many churchgoers, when asked to donate toward the construction of a new building, may not be willing (or able) to donate cash but are willing to dig a trench or wire the electricity. While that’s extremely generous, and can be a great community-building activity, lenders like to work with general contractors and construction companies so they can monitor the process (for all the reasons we’ve outlined in the topics above). It may be that your lender is not comfortable with you entrusting your plumbing to a member of your congregation who is a retired plumber. The lender wants to protect their investment–and, remember, they’re very concerned about price overages. If you do want your congregants to participate in the building of the new church, make sure that it’s worked into the estimate and bid, and that they are listed as subcontractors, not as mere volunteers.