General preparations | Building lot/property | Home plans/Specifications | Engineering | Building permit | Subcontractors and bidding | Lien Waiver | Contracts and scheduling | Financing
Whether you are building your dream home or adding on to your current home, you are going to need money. Unless you have substantial savings, you will need to get financing. However, don't be discouraged if you don't have much money, with a little resourcefulness you can still get your project off the ground.
To contract your own home you will need a construction loan and permanent loan. The construction loan is a short term loan (6-12 months) used for the construction of the house.
Before a bank will approve a construction loan they will require that long-term financing be secured. They will also look at the appraisal of the property, and the cost breakdowns of the project. They will want to make sure that the house can be built for the amount of the construction loan. If the breakdowns are not realistic they may ask for revisions and more bids, or they may suspend or deny the loan entirely. For example, if the house appraises for $150,000 and you claim to be able to build the house for $105,000 the bank will want to know how that can be done. If the bank knows that you as an owner-builder will provide some of the labor they know that may be possible.
The bank makes a profit by charging fees and interest on a construction loan. The interest rate on a construction loan is 1-2 points higher than a the long-term mortgage rate. For example if a competitive 30 year mortgage is currently at 9% the bank may charge between 10-11% for the construction loan.
Once the construction loan is approved, the building process can begin (assuming that you have acquired a building permit). As work is completed, monthly draw request are submitted to the bank and then paid out to the subcontractors and suppliers. The bank will make periodic inspections to ensure that the material and labor relating to the draws are on site and installed.
At the completion of the project the long-term financing pays off the construction loan.
Generally the bank lending construction money will require that the building lot is at least 50% paid off. Otherwise they will not make a construction loan. This 50% acts as a large down payment. It is their "insurance policy" project fails.
It also common to have a property owner subordinate their position to the bank. This means that the property owner take a position as a creditor to your project but in "second position". In other words, if you fail to complete the house on time and on budget and the bank repossesses the property, the bank will recover all of their expenses before the property owner is paid for the cost of the property. It is possible that no money will be left to pay the property owner in which case he will have to try and recover money from the owner-builder.
The property owner, like a bank wants to make sure that you can build the house on time and on budget and he usually asks for a down payment and a payment schedule or a date for full payment of the loan. If a property is "less desirable" or you live in a "buyers market" subordination is common.
Before you can apply for a construction loan you will need to be approved for permanent financing. The lending company will want to appraise the future value of the home and property (by checking the plans and specs). Once they arrive at an appraised price they can determine the amount they will lend. Usually it is a percentage of the total value. For example, if your home and property appraise for 100,000, they may lend up to 95% or $95,000 on a conventional loan. They will also determine your loan amount by debt ratios, credit history, and income.
Banks, credit unions, mortgage brokers, private, family, savings, Equity from home sale, Retirement funds (i.e. 401k) are some of the more common sources of building financing.
Banks provide both construction and long-term loans. However, they often have more difficult underwriting guidelines and more policies regarding owner builders than credit unions and mortgage brokers
Credit Unions provide competitive long-term loans and in some cases construction loans also. They often provide a construction to permanent loan which reduces the loan fees by combining the loans into a package loan.
Mortgage brokers can usually get very competitive rates for long-term mortgages, however they often don't provide construction loans.
Private financing for owner builders is common for a construction loan because formal lending institutions often restrict such loans to those who are licensed and insured contractors. However, this usually means higher interest rates.
Savings/IRA-Savings are an important aspect when building a house. The more money that you have at your disposal the more favorable in the eyes of the bank.
Collateral such as property that you own or equity in your existing home, can be used for a construction loan.
Family/relatives can also be a source construction money.