Construction Loans to Build Your Own Home
Construction Loans to Build Your Own Home
Are you thinking you might want to build your own home? Can you actually get a construction loan as an owner builder in today’s world of real estate? You can get a loan to build your new dream home. However, much like obtaining a loan to buy an existing home today, you will need to jump through some hoops to make it happen.
When you build your own home, the first hurdle you will come to will be your credit score and credit history. If you don’t have stellar credit, don’t waste your time. The reason being, even if you can get a construction loan to build your own home, a mediocre credit score will increase your borrowing costs. If your credit score goes down by just 100 points, your loan rate can go up two percent or more. So, be sure to get your credit in order prior to starting your dream project.
Interest rates on construction loans for owner builders are in the seven to nine percent range. Yes, that’s pretty steep considering bank rates on savings accounts are in the negative range…or so low they seem. So why are you paying such a premium for the loan? It’s appears to me it’s really about the risk associated with construction loans. If you don’t finish the job and leave them to clean up the mess, there could be considerable costs to the lender. This potential exists however with or without a professional general contractor at the helm.
Don’t forget, you will be paying interest only on the money you have drawn on the loan. So, as your schedule progresses, you will only pay on the work that has been completed. And typically, your contract (that you create with your attorney) will give you thirty days after completion of any work (or delivery of materials) to pay. So, you will have some float time after work is completed.
Typical fees for owner builder loans include loan origination fees, underwriting and document preparation fees, as well as the typical closing costs. The total loan fees when you build your own home typically range in the 4-5% range (of the total loan amount). So, as a simple example, if your home and lot together will cost $100k, your fees will be somewhere in the neighborhood of $4000-$5000. One reason for the rather high cost is the short term of the loan. Everyone involved has a lot of work to do to put this loan together. And typically, the money is paid back within six to nine months. This compared to fifteen to thirty years for a traditional mortgage.
In most cases you will need 25% equity to start your project. Typically, the land value is included in this calculation. So, let’s say you own a lot that you intend to build your home on and it’s worth $25k. The value of the lot will fulfill the 25% equity requirement if the total value of land plus construction is $100k or less. So if the total value will be $100k at the completion of the project, you can borrow up to $75k.
Most lenders require inspections to be performed to make sure the actual work is progressing as you build your own home. The idea being, you could draw money on work that is not yet completed. This can get you and the lender into trouble. As long as the money is being put into the home and increasing it’s value, the lender has some protection. The frequency of inspections are typically after three or four budget line items…or sometimes after every draw…it really depends on each lender.
Tips from a Builder
- Get-a-move-on: Once you start construction, you want your schedule to progress as quickly as possible in a quality fashion. Every day that goes by, you are paying 7-9% interest on the money you have drawn. The faster your schedule progresses, the lower your overall loan costs will be. Also, most construction loans are setup with a maximum term of nine months. You may be able to get an extension, but it’s better to get it done before the deadline. The other benefit is…most of these loans don’t have a prepayment penalty…so you get the benefit of finishing early.
- Build up your credit: Don’t try to build your own home if your finances aren’t on solid ground. Having great credit will lower your borrowing costs and give you piece of mind.
- Contingency: As a builder, I always include in my budget a contingency for any new homes I build. This is money that is there in case I blow one of my budgeted line items. Don’t look at this as money you can spend. The contingency budget is for cost over runs from unexpected things like weather, poor soil conditions,…etc.
- Check out construction to permanent loans. These can be more affordable in some cases since you only pay closing costs once.