How to Build a Home…Step 1 The Overall Budget
This is our first blog post for our new How to Build a Home Series where we plan to take you through all the steps required. Building new can be a complicated process but it doesn’t have to be. Our goal is to break the process down so you know exactly what you are getting into. Your first step will be to come up with your overall budget. Determining your overall budget to build a home is really about finding out what you want to spend. For most of us that don’t have unlimited funding, we are looking to find out how much we can afford for the completed project.
Why Start with Your Overall Budget?
You may be asking why we want to start with your overall budget. Well, one of the worst case scenarios for building a home is to get two thirds of the way through the project and run out of money. Once you take the last bank draw on your loan, there is no going back to ask for more. And unless you have another bank account or a generous friend to borrow the money from, you will be left with an unfinished home. To make matters worse, most municipalities won’t let you move in until the home is 100% complete due to liability reasons. And even if the municipality does look the other way and let you move in, you will most likely have fees to pay for any expired permits.
Ok, so I can’t move in…so what? If you get to a point where your home is 80 percent done and you run out of money, you will still be paying interest on the money you have taken from the bank. The construction loan to build a home is typically at a much higher rate of interest than a traditional mortgage due to the risk involved. You will be stuck with an expensive loan on the home and in many cases, you will still be paying for a mortgage or rent to live elsewhere. You may also have a problem with the time period of your loan. Your loan will have a specific time period in which you will be required to finish the home. If you’re not finished by then, the bank could possibly call the loan…which leaves you in default.
Another reason to determine your overall budget to build a home first is to save yourself some time. If you start looking at land and house plans without knowing your overall budget amount, you could be wasting your time. Maybe during a search you find a building lot you really like for $100k with a great view. But later on you find out your overall budget is $150k which won’t accommodate the lot and dream home. The same goes for house plans. You don’t want to spend time and money working with an architect to then find out the home you are planning is to expensive for your overall budget.
One of the best ways to determine your budget for your new home building project is to talk to a bank loan officer. Things have changed dramatically over the last few years when it comes to residential loans of any kind. So, don’t rely on information you may have from several years ago. If you plan on building your own home, you will want to find a bank that provides loans to owner builders. The bank will have standard calculations they use to calculate the top of your budget, similar to a traditional mortgage application. However, it will be slightly different since there is more risk involved with a new construction project. They will look at your monthly expenses, income, credit,…etc. For more information on owner builder loans, check out our on Construction Loans to build a new home.
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. If you haven’t yet purchased a lot, talk to your bank about the equity you have available to include that number into the overall budget for the project.
Build a Home with Cash
A great way to finance your project is with your own cash. If you’re lucky enough to have enough money available to purchase the lot and build the home, by all means do it. Just make sure you have a cushion just in case extra expenses come up. It’s better to go to the bank and get financing before you need it…as opposed to when you are in desperate need. By using your own money, you will save big on bank loan fees and interest. And, you will have extra flexibility in that you won’t need regular bank inspections, draws, paperwork…etc.
When determining your overall budget, be sure to include a percentage for unexpected expenses. When I build new homes, I always include a budget line item for unexpected things. For your project, it’s a good idea to figure in an extra ten percent to cover unexpected items. So if the bank tells you the top of the budget to build a home is $100k, it’s a good idea to consider it to be $90k.
Check out our video, Build Your Own House: How Much to Spend? for more information in determining your overall budget. If you plan on owner building, you may also want to check out our resources page on How to Build Your Own Home. Stay tuned as this is only Step One in our series on How to Build a Home.