Posted on Nov 17, 2021 in
On the Porch with Patti
Whether you’ve “always” wanted to build your own home, or you’re just starting to think about it out of frustration from not being able to get a home you want under contract, there’s a lot to consider before making the building versus buying decision. It’s very common for people to think building would be less expensive, and/or easier because you can do “everything the way you want it.” Bottom line, it’s not cheaper to build, and takes considerably more on your part to build than just having the down payment and closing costs, and a contract on a home.
Speaking of having the down payment and closing costs, that’s normally sufficient, along with qualifying income, to obtain a mortgage loan to buy an existing home. That however is not the case if you’re wanting to build. When building, you must be much stronger in the Asset department, meaning you need to have more money. When you go to get a construction loan, they want to see that you have plenty of liquid cash available for at minimum 10% to 15% of the cost of your project, over and above what you would be bringing to closing. That’s because Murphy’s Law is alive and well and lives in the home building business. Construction lenders want to see CASH. They would rather see people with some current debt and more money in the bank than little or no debt and less money in the bank.
Construction loans are a different type of loan, but a very important part of the project and there are several reasons WHY you should always get a construction loan when building a home, even if you have the cash to build it out of pocket. The construction loan process has a system of checks and balances built into it that help keep the project on track, by way of controlling when funds are distributed. There are interim inspections required between draws, so there is another party for the builder to be held accountable by, and they’re controlling their funding. Another thing that’s required prior to closing on a construction loan is an appraisal, where they take the plans and the bid and they do an appraisal of the home as “finished” to ensure that when the project is done, you won’t have considerably more money sunk into the project than it’s going to end up being worth. This is a HUGE issue and happens often when people decide to build out of pocket and “refinance it later.” The problem doing it that way is that it becomes a cash-out refinance, which there’s nothing wrong with, BUT the interest rates are slightly higher than they would be by refinancing a construction loan.
Once the home is approximately 45 days out from completion, it’s time to start the refinance process from the construction loan to a permanent loan, sometimes referred to as a “take out” loan because we are taking the construction lender out of the process. Construction loans are a temporary type of loan and construction lenders want to be your friend for a very short time. That’s why they want you to be pre-approved for the permanent loan before they do a construction loan, they want to make you sure that you qualify for long-term financing and that
they won’t be stuck with you for months or years beyond your house being done. And since construction loans are at adjustable rates, it’s in your best interest to get that construction loan refinanced as soon as you can once the house is complete.
There are two HUGE mistakes you need to avoid when you go to get a construction loan. Number one mistake is people don’t borrow enough money. And you can’t go back in the middle of building and get more on your construction loan. Remember Murphy’s Law, it’s always going to cost more and it’s always going to take longer than you thought, that’s just the way it is. The normal thought process is that you’re thinking cost is X, borrowing Y and I’ll have Z to spend on it. Then “Z” becomes Z+++, and suddenly what you thought was furniture money is disappearing in other directions you weren’t expecting. As far as borrowing “enough”, on a construction loan, you only pay interest on the money that you use WHEN and IF you use it. So bottom line, borrowing more won’t cost you if you don’t use the extra. BUT, although they say nothing is impossible, the closest thing I’ve ever seen is trying to borrow more money in the middle of building. It’s not going to happen, so don’t get caught short. That’s also why they want you to have money, you’ve got to be prepared to cover those extras when they come up.
Second biggest mistake people make is thinking they have enough money to build out of cash, and then it costs a lot more and they run out of money, and just need “a little to finish it up”, it’s not going to happen. You need to hope to have a rich uncle or super good friend that can lend you that little, because that’s the only way you’re going to be able to borrow it. Don’t put yourself in that position. And finally, wait until you get your construction loan finished and closed BEFORE you start building anything, or you could derail the whole process. I know people are excited and want to get started, or just “do the frame” or just pour the slab or whatever. First, close on the construction loan, then, start construction.
Happy Buying or Building y’all.
For more information, visit www.bakermortgage.com.
