Financing Building a Home
In today’s market, it may seem easier & more time-efficient to buy land and build on it. The stress of offering, negotiating multiple offers & a timeline that is undefined can be grueling. Building your own home is one way to get around the traditional buying process, but it requires a bit more. Financing building a home is a completely different process than your traditional conventional mortgage. So how do you know if it’s feasible for you?
Conventional vs. Construction Loan
Financing building a home is tricky. Why? Look at it from the bank’s point of view. They are basically promising you money for something that doesn’t exist yet. Scary, right? They want to not only make sure that your income & credit is strong, they also want to make sure that it’s not too risky for them.
A construction loan is typically a short-term loan (1 year) to cover the cost of building your home. It typically has higher interest rates because it’s a greater risk for the bank. While the project is going on, you’re just paying on the interest, not the principal. Once the project is finished, you can refinance to make it a permanent loan and decrease your interest rate. You can also take out another loan, called an “end loan”, to pay off the construction loan (investopedia).
Preparing to Buy
Unlike a conventional loan, where you can put 3-5% down, a construction loan requires more. Standard down payments are usually 20 – 25%. The other upfront cost to consider is whether you’ll need to finance purchasing the lot, or if you’re buying the lot upfront. If possible, it’s easier to buy the lot in cash so that you just have to worry about your construction loan.
As would anyone lending you a large amount of money, the bank wants to see proof of EVERYTHING. Your lender will want to ensure that the process has been mapped out, approvals have been granted, & timeline and budget have been solidified. They’ll need to see that you have a contract with a licensed general contractor with a home-building history. The bank will need to see everything from floor plans, building materials, ceiling heights & utility information.
Financing building a home has layers to it. When working with a licensed contractor to build your home, you have to get through certain layers. If you’re a general contractor yourself, there are more layers. You’ll have to be able to prove that you have extensive home-building knowledge & background. If that’s the case, you’ll apply for what’s called an owner-builder construction loan.
Is It Worth It?
The biggest hurdle is saving up for that large down payment, or the outright purchase of land with cash. Once you have obtained that & been approved for a construction loan, patience will be your best friend. Patience, and some extra $$ for a just-in-case fund.
The benefits of building is that, if all goes well, you’ll get a custom, brand new home out of the process! No multiple offers or buying a home that needs a ton of work. However, there are issues in building a home too! Construction timeline is very variable, building materials are not cheap, & issues during construction can arise. Whatever direction you choose to walk, know that it’s not always a walk in the park. Things go wrong, there are unexpected hurdles and costs no matter which way you go.
While there will always be hoops to jump through, working with a knowledgable lender & Realtor to walk you through the process is important. They’ll keep you on track & organized to ensure that you are prepared to break ground!
Questions about building?
Let’s get those answered and start working towards your next home!