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FINANCING
THE CONSTRUCTION
Up until a few
years ago, the financing of residences took one of two forms: "construction
financing" and "permanent financing". That was because there is
one level of risk involved in insuring a home during its construction and
another level of risk after the home was completed. The situation today is
similar except that there are all sorts of new programs that might be considered
"semi-permanent" financing. By that I mean short term loans on a
completed house; some with interest only payments.
In this
discussion, we are going to stick to the basics without getting into the more
exotic hybrid programs that are available.
Most people
(owners) planning a custom home will need a construction loan for the period
when the house is under construction and a permanent loan (mortgage) that will
finance the home for the duration of the time that the owner keeps his house. Or
until he or she sells or refinances it.
Here are the
differences in the two. A construction loan is relatively short term and is
usually made by a bank. The loan amount is determined as a percentage of the
appraised value of the house and lot, based on the plans. Lets say that an owner
has purchased a lot and paid "cash" (without any loans) for it. The
price of the lot was $75,000. The owner has secured plans for a 3,000 s.f. house
and has gotten a bid from a builder to construct the house for $300,000. Now
let's say that the bank has secured an appraisal for the house and lot showing a
valuation of $400,000. They will probably agree to loan you 75% of the appraised
value ($300,000). They may agree to only loan 75% of your "costs".
Your cost being the cost of the lot plus the cost of the house ($375,000);
meaning that they would agree to loan a total of $281,250. Depending upon your
banking relationship, your net worth, your income and your experience in
building, you could be expected to pay a loan origination fee of 1% to 3% and
interest rates of 1% to 4% over the prime rate. You only pay interest only on
the money that has been disbursed, not the total loan amount. Construction loans
are usually made for nine to twelve months (the time it should take to build the
house).
After the house is completed, a permanent mortgage
(usually 30 years), pays off the construction loan and serves as financing until
the owner pays it off, refinances or sells the home.
Some mortgage companies offer a "C&P"
(construction and permanent) program whereby there is only one lender and one
closing. After the house is completed, the loan automatically switches from
"construction" (interest only) to "permanent" (amortized
principal and interest payments).
One of the first
things you want to do in your quest for a custom home, is to contact your bank
or a mortgage broker to see how much of a loan you can qualify for, based on
your income, credit rating, net worth and other factors.
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"It's
unwise to pay too much, but is worse to pay too little. When you pay too much,
you lose a little - that is all. When you pay too little, you sometimes lose
everything, because the thing you bought was incapable of doing the thing it was
bought to do. The common law of business balance prohibits paying a little and
getting a lot - it can't be done!