Monday, April 18, 2005

How Construction Loans Work

There’s probably nothing more challenging and fun than building your own home. It helps to understand how your lender sees you and your project: they want you both to succeed!

Whether you intend to build your own home or hire a professional architect or builder, you need to know a few facts about your project before you apply for a Construction Loan: 1. The specific time frame required to build your home, 2. How much equity (cash and/or land) you are bringing into the project, 3. How much it will cost to build your home, and 4. Liquid assets you will need (to live & operate) during your construction period. Naturally lenders have higher credit standards for complex projects. This is NO place for the first time homeowner.

Your Home Building Team

At the outset, whether you are designing your own home or hiring a home designer, you will need to find a lot suitable to your needs and design. A realtor working your architect or builder is a great asset. Working with a designer or selecting a plan for your home that reflects your personal style is the fun part! It helps to have a lender involved early in the process who understands what you are trying to achieve.

It’s very smart to get a landscape designer working with your team before anything happens on the site. In the case of our Pacific Northwest terrain, many valuable trees and plants may already exist on your lot. Heavy equipment can compact soil and undermine your site. Having a professional identify and protect what is there can save you many thousands of dollars trying to rebuild nature’s work.

A home’s impervious surfaces (your roof and driveway) displace rain and ground water from naturally seeping into the soil. Runoff is not usually a good thing in terms of flooding or pollution risk. Increasingly, builders are being asked to mitigate impervious surfaces with water catchment systems. Check with your local Building and Planning Department about their permit guidelines. Naturally dry regions will have very different guidelines for resource conservation.

Greenbuilding = Future-proofing
Greenbuilding and Energy Star are becoming the new industry catchwords. These higher building standards insure your home will be ‘future proof’ as well as be more pleasing and healthy to live in. LID or Low Impact Design starts literally from the ground up. It's a good idea to carefully select your site and note any potential problems (like wetlands and slope) with the help of a surveyor or environmental engineer. Certified greenbuilt homes also cost less to maintain and heat or cool over a lifetime. Local energy companies offer rebates for high efficiency fixtures and lenders are starting to talk about how lowered energy costs may offset a borrower’s cash flow requirements. Some lenders offer an Energy Efficient Mortgage rebate!

Working With a Construction Lender
The best construction lenders are specialists with highly skilled in-house teams who review and approve your plans, your builder and own creditworthiness. The process is more involved than a traditional mortgage because you are asking to borrow funds for something that does not yet exist. Interest rates are often higher during the course of construction phase due to the increased risk.

You must provide detailed plans, engineering, sewer/water plans, all permits, and a list of materials and full cost breakdown with your application. An appraiser reviews these documents in order to value the proposed home. After it's complete, your appriaser will return and verify that it has reached projected value and issues a completion report.

Pricing Your Project
Hard costs (materials, labor) and soft costs (design, fees) are used to establish your Cost Estimate. In addition to building costs, lenders encourage you to budget realistically for landscaping, window treatments and other fixed assets like fencing and security systems that will enhance your home’s final value. Your appraiser can assist your understanding of exactly which upgrades will add value to your specific home.

Your mortgage broker will order your appraisal, review your budget—factoring in contingency fees and closing costs—and negotiate your terms. Once the loan closes, you start building. Your bank inspector authorizes the flow of funds and helps keep your project on track.

The Building Phase
After your foundation is in, your lender’s agent inspects your site on a monthly basis to verify that the work has been performed to standard, before authorizing that month’s payment. It’s quite an efficient process once you get the hang of it. Note: inspectors just report what they see to the lender. Lenders won't authorize payment for anything that is not complete or fully installed...for your own protection.

When your home is near completion, your appraiser performs a final inspection report before you move in. Any remaining funds can be reduced from the principal or used for additional landscaping or fixtures. You then convert the principal owed to a permanent mortgage. 

Remember, once you have built or renovated your home, you will enjoy your personalized results for many years. Home Building & Renovating can be rather infectious—you may want to do it again!

Wishing you every building success! 

© 2005 susan templeton

Custom Construction Loans

Construction Lenders offer a range of funding options for Owners, Owner/Builders and Investors of 1-4 Unit Residential Dwellings for up to $6 million dollars.
It wasn't so long ago that if you wanted to build your own home, you had to first either buy your land or get a lot loan, then get a construction loan, pay the closing costs, build the home, and then refinance the whole kitandkaboodle into a mortgage = 3 hassles and 3 sets of closing costs!

Custom-Perm Loans (1- Step, 2-Step or One Time Close)
Custom Construction loans are designed to allow a home owner or investor to custom build a home and cover the cost of land, design fees, contractor(s) and other hard costs in one loan.
After the Construction Term (4 months to 2 years) is finished, your loan is then converted or ‘rolled over’ into a Permanent Mortgage. There are no closing costs when you convert from the construction phase to your permanent mortgage unless you change lenders.
Interest payments may be rolled into the loan so you don’t have to make payments out of pocket while you are building. A guaranteed interest rate at roll-over may be negotiated at the beginning of the construction term, as long as your project is on time and budget. The advantage to a builder is that the borrower carries the financial risk. The advantage to the homeowner is true ownership of the project and the ability to personalize the final home to a far greater degree than a ‘Spec’ home.

Renovation Loans
These loans are designed to allow a prospective Home Owner or Investor to acquire a home in need of repair with extra funds for the purpose of upgrading the home. An appraisal determines the ‘as is’ value and the ‘as built’ value of the home. Your lender manages your budgeted renovation funds for up to 6 months, during which time payments are on a monthly schedule, until the final appraisal or inspection is complete. There is also one closing, similar to the Custom-Perm loan.

Land and Lot Loans
These loans allow prospective home owners to acquire land upon which to build a home. The terms are usually for 1-5 years, after which time you may convert to a Construction Loan. Lenders require 25-30% down payment due to the higher risk of an unimproved property.

Bridge Loans
If you currently own a home (in your lender's licensed region) with significant equity, some lenders will allow you to 'tap' that equity during the building phase, assuming you sell current home after your new home is finished.

Lender Criteria
If you have very good credit and can effectively navigate paperwork; you may be a good candidate for a construction loan. They require much more effort than a standard mortgage! Lenders rate risk on the same criteria as conventional loans, with moderately higher rates during the short Construction term due to the higher risk involved.

Custom Building Advantages
There are real advantages to both the builder and homeowner. For starters, your builder will appreciate not having to wear the financial risk (or tying up assets) and being paid every month. As the homeowner, you have real ownership of the project. One advantage is saving at least one set of closing costs. When you purchase a home from a builder, their financing costs are passed onto the buyer. As a homeowner in charge--chances are you can build in a higher quality standard in your upgrades and personalized finishes than you would with a spec built home.

A word of encouragement: find a good builder or consultant to oversee your project and don't try to do everything yourself unless you have extensive and recent building experience!

Wishing you every building success! 

©2005 susan templeton