How to build (and pay for) your dream home
Today's tight real estate markets and low interest rates have increased real estate prices in many areas.
Instead of competing to buy an existing home, you might consider building a new home.
There are great advantages to building your own home: you have control of the layout and materials, you can choose the location, and there is no competition from other buyers.
However, financing a home construction project is more complicated than buying an existing home. Therefore, it is important to understand the process and the costs involved before you get started.
Review Your Construction Loan Options (May 14, 2021)
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Building a House: The Basics
Building a home is very different from buying a home from the market – especially when it comes to financing construction costs.
A mortgage on an existing home is pretty simple: you take out a single loan that includes an application, appraisal, deadline, and set of closing costs.
With a new build, the process can be complicated. It is not only a mortgage to consider, but also the financing of land, labor and material.
When considering building a home, here are some things to keep in mind:
Financing your dream home project may require a series of loans with multiple rounds of paperwork and fees. However, certain loan programs and lenders can consolidate this process. "Once closed" construction loans can help you finance land, construction and mortgage with a single loan. Expect a larger down payment for a construction loan than for a traditional mortgage – usually 20% to 25% (versus just 3% when buying a home) Planning is essential. The lender needs to approve your builder and your building plans along with your personal finances. Build versus Buy – Costs vary widely by location, but can be similar in many areas
If you are looking for a custom home in your ideal location – and you have the time and money to take out a construction loan – building a new home might be a great choice.
However, if you are in a rush, it may be better to buy an existing property from the market.
Buying a home is usually faster than building a home. Typically, there are fewer down payment and credit worthiness hurdles to overcome.
Explore home loan options to build or buy (May 14, 2021)
How construction loans work
One, two, or even three separate loans may be required to build a home. For example, you need funding for:
Buy the land Pay the construction costs Pay for the land and construction loan with a standard mortgage that you can pay off over a period of up to 30 years
“Real” construction loans are short-term loans, usually 6 to 18 months. They are only used to finance housing construction (not for land or permanent mortgages). In most cases, you only pay interest on what you borrow.
Construction loan rates are usually variable interest rates based on the key interest rate plus a certain percentage
Some programs allow you to wrap home loan interest in permanent financing. This can be helpful if you are also trying to pay off an existing mortgage or rent as you build your new home.
What does a home loan cost?
Expect more for home finance than a traditional home loan – even if the cost to build or buy is practically the same.
New home loans cost more for several reasons:
More risk – Lenders take greater risk because there are more variables in the building process. And the house that will be used as "collateral" for the loan amount does not yet exist. This risk results in higher interest rates compared to standard mortgagesMore paperwork – Money is paid out at various points in the construction process and the lender must verify that enough work has been completed to warrant the next "draw" of funds
Lenders also require a lien waiver to prove that builders have paid their subcontractors before issuing drawings.
The drawings can be made gradually. For example, a lender can break the project down into seven phases and release money in each phase. Or they allow builders to request money based on the degree of completion.
In general, the more drawings are allowed, the nicer it is for the client. However, each draw increases your costs due to the administrative work involved.
Is It Cheaper To Buy Or To Build A House?
The idea of building a new home might scare you because you think it is the more expensive option. However, depending on the location and living characteristics, the cost of building a home is comparable to buying an existing home.
According to the 2020 study by the National Association of Home Builders, it costs $ 296,652 to build a new home.
The real estate site Zillow puts the average price of an existing home at $ 269,039.
Both numbers vary widely – in some cases by hundreds of thousands of dollars – depending on the state and area in which you plan to buy or build.
Check your eligibility to buy a home (May 14, 2021).
Types of construction loans
Some home buyers use up to three separate loans to build a home: one to buy the land, one to build the home, and one to convert the construction costs into a permanent mortgage (which is like a typical Home loan works).
You can consolidate these steps, especially if your builder is willing to fund the construction costs, until you use a standard mortgage loan to pay off the builder.
Or you are looking for a mortgage that will finance the entire process with one loan.
Construction loans closed once
Some lenders offer one-time-close or construction-to-permanent loans. These are construction loans that are converted into traditional mortgages after receiving the certificate of use for your home.
For example, the Fannie Mae, FHA, VA, and USDA programs offer one-time tight home loans.
These mortgages only require one deal and you are only approved once, reducing the risk of two approval processes. Getting a fixed rate mortgage allows you to secure your interest before you start building.
For more information, see:
However, it can be more difficult to find these mortgage programs from the major lenders. So you should expect to have a look around if you want one of these loans.
From the lender's standpoint, it might be easier to get separate loans for each stage of the construction process. This may also give you more control as you can buy the best rates for any loan.
However, using two or three loans means paying two or three sets of closing costs – and going through the underwriting process multiple times.
Review Your Home Loan Options (May 14, 2021)
Fannie Mae Construction-to-Duration Loans
Many buyers who prefer the "single-closing" strategy opt for the "Fannie Mae" option for the permanent loan.
With this program, you would not have to make any mortgage payments while the house is under construction. Instead, the loan repayment begins after the completion.
As with any permanent home loan, Fannie Mae will include the cost of construction in your permanent mortgage once you have a certificate of use.
This loan can generate "instant home equity" because Fannie Mae bases its loan-to-value ratio on the cost of construction, including the purchase of land, if the number is less than the final home value.
For example, if a house cost $ 200,000 to build but a surveyor values it at $ 250,000, Fannie Mae would still base his LTV on the $ 200,000 construction cost. You could wager $ 40,000 (20% of $ 200,000) and take out a $ 160,000 loan.
With a home worth $ 250,000, you immediately have $ 90,000 of home equity ($ 250,000 minus the $ 160,000 loan balance). It's important to remember that construction costs and property values vary widely from state to state.
The other financing option is a construction loan with two deals – two separate loans. You get a home loan first and then you can repay it when construction ends by refinancing yourself into a permanent mortgage.
This means applying for two different loans with two degrees and all related closing costs for both.
Many lenders require that you have a permanent mortgage before they release funds for the construction process.
This two-loan strategy gives you flexibility when there is a construction delay that requires you to extend the term of the construction loan.
You may have access to better refinancing options than a permanent or one-time graduate loan.
Which construction loan is best?
The beauty of a permanent mortgage is that you avoid multiple loan applications, packages of lender fees, and property fees.
However, the main disadvantage is that these loans tie you to your home builder lender.
You don't always know what mortgage rate you will be offered until construction is complete. If locked, interest rates may have dropped during the construction period and you may get better results with a different lender.
Construction loans once closed can be easier and cost less upfront, but you could end up with a higher mortgage rate in the long run.
Never accept your lender's permanent rate without comparing current competitor mortgage rates.
Mortgages once closed can save you money by consolidating some fees. However, it is not a saving if the interest on your permanent loan is significantly higher than the current mortgage rate.
If you plan to keep your home and mortgage for many years, it may be worthwhile to replace your permanent loan with a better one. You may also be able to negotiate a lower rate with your home builder if you bring in offers from other lenders.
Refinancing a home loan into a mortgage loan
If you are using a short term home loan that only covers construction costs, you will likely need to refinance into a traditional mortgage after construction is complete.
Construction loan only individuals may be home builders planning to act as their own contractor or take over the lion's share of the building themselves.
Many mortgage lenders do not work with home builders because they cannot be sure that the home will actually be a primary residence and not a "special" business.
You can also choose a home-only loan for more control over permanent funding.
You can buy the lowest mortgage rate once the house is ready to move into.
How To Buy A Refinance For A Home Loan
If your home is near completion, compare the mortgage rates and consult the lenders. Don't let your credit rating go down during construction as it will increase your interest rate and make it harder to get approval.
Almost any program open to traditional home refinancing should be available to you. Get multiple quotes from competing lenders and try to get them on the same day so you can make an effective assessment.
Once you have your lender, get your application approved asap. You no longer want costly delays once your home is ready to move into.
How Long Does It Take To Get A Home Loan?
A 90 day home loan approval process is common as the lender must approve the project and the builder, not just you.
Your builder should submit construction plans – including a material description and a cost breakdown – for evaluation by the lender.
The builder's blueprints should include floor plans, ceiling heights, and schedules – everything you need to create your dream home. Seasoned home builders likely already know your lender's requirements.
Once the lender has your builder's blueprints in hand, they'll assess the value of the home once it's completed.
Building loan approval often takes up to 90 days. Building the house itself can take anywhere from 4 months to over a year.
Your lender will also evaluate your personal finances during the approval process.
Most programs require a solid credit rating, a good FICO score, and a steady income. You may have to repay loans during construction. Lenders prefer reasonable savings on cost overruns and unexpected costs.
Most lenders are helpful in this process and even offer builder approval packages.
However, approval policies, costs, and loan terms can vary significantly. So, compare construction loan costs to see what you can afford and carefully interview lenders before applying for loans.
Start getting your home loan approved today (May 14, 2021).
How long does it take to build a house?
On average, building a house can take anywhere from four to twelve months.
The length of time depends on the complexity of the job, the skills of the client and external forces such as the weather.
A small production house on a fraction of an acre property can take four to six months. A huge customs house on an acre or more takes 10-16 months. The availability of manpower and materials also affects the completion dates.
According to the US Census, average construction times also depend on your location:
Source: U.S. Census, New Housing Features, 2018. Image: ThePlanCollection.com
Problems before construction often slow projects down when clearing and preparing land reveals surprises, especially on large lots.
Allowing can also hurt your schedule and be a bit political. And your community requires you to obtain permits, code inspections, and permits throughout the construction.
The bigger the house you are building, the more patience and perseverance you will need.
Selection of a builder or contractor
To get funding for your dream home project, you need to work with a qualified builder or general contractor.
You may have envisioned yourself to be a builder and you may have the skills to make it happen.
In reality, however, you would have to be a builder with enough pockets to self-finance the project as most banks do not support a do-it-yourself project.
In addition, most lenders have standards for home builders. If yours doesn't meet these requirements, you won't be able to finance your construction with a mortgage lender.
This can be a benefit to you – by protecting yourself from unqualified builders, you are protecting the lenders as well.
How to Find a Qualified Builder
You can check your builder's license status and usually find complaints by looking online for your state contractor's board.
Or simply search for the name, location, and word "license" of your prospective contractor to get this information.
Personally interview at least three builders or general contractors on your shortlist and find out all about how they complete construction projects. Know if your personalities are intertwined since you have been working with them almost every day for six months or more.
Note what is included and what is guaranteed (e.g. defects, overruns and deadlines).
As with any expensive contract, don't sign anything you don't understand. Get a buyer’s new build real estate agent or real estate attorney to help if needed.
How much can I borrow for my housing project?
When buying an existing home, you can finance up to 100% of the home's value depending on your loan program.
Not so with building loans. Expect your lender to fund only 75% to 80% of the future value of your home.
This results in a down payment of 20% to 25% for you as a borrower.
Lenders require large down payments because of the commitment of up to a year or more to build a home. Borrowers who pay a substantial down payment tend to be less likely to walk away during the project.
The amount that you can borrow after your deposit is paid depends on the loan program used.
FHA and conventional loans have different maximum amounts, and lenders can set their own limits. Check with your lender about how much you can borrow based on your loan type and finances.
Find out how much house you can afford
You control the cost of building a house out of pocket by creating an affordable budget.
Once you know what to spend, work with a reputable contractor who knows the area and can tell you what you can and cannot afford to include in your new home.
The mortgage reports have a home affordability calculator that can help you figure out how a monthly payment converts into a loan amount, or how much home you can afford given your income and ongoing expenses.
Start with the basics and add a 10% over budget pillow. If you can afford extra amenities, add them.
Construction costs can escalate so budgeting for this is wise. For this reason, lenders often add 5% to 10% for contingent liabilities.
For example, if you want to spend $ 200,000 on buildings, you might need to qualify for a $ 220,000 loan.
The builder should include a material description and cost breakdown that you will need when applying for a home loan.
Check Your Maximum Loan Amount (May 14, 2021)
Building versus buying your dream home
Building versus buying is a personal choice, and your personal finances and preferences should guide you.
When making your decision, consider these advantages and disadvantages.
Benefits of Buying an Existing Home
Buying a home can be faster and easier than building your own.
You will avoid unforeseen delays in the construction process and avoid paying rent or mortgage while you wait for your new home to be completed.
In addition, existing homes are often located in established residential areas. Typically, this means they have mature trees and landscaping that add significant value to the home.
Older trees and bushes can also lower energy prices. In summer, the shade of tall trees reduces cooling costs. In winter, old trees and bushes reduce heating costs by blocking the wind.
Shopping in a well-developed area means you can also walk to amenities such as shops, restaurants, and entertainment.
Cons of Buying an Existing Home
Depending on your age, buying an existing home means buying all of its troubles.
Older homes wear out more, are often less energy efficient, and sometimes require expensive maintenance. How much that is and when it is needed depends on the age of the house.
About 50% of the average home will need to be replaced in the first 30 years. A house with a heating or cooling system, appliances, or roof that is more than half its useful life means you will likely be replacing these items.
The cost of owning a home can run into thousands of dollars depending on what repairs or replacements are needed and where you live.
If you are building a home, there may not be any significant maintenance costs for the first 10 years. And you will likely have some sort of warranty coverage.
Research shows that houses built after 2000 save their owners 21% annual energy bills.
Check your eligibility to buy a home (May 14, 2021).
Advantages and disadvantages of building a new house
When you build your home, you are in control of all of the decisions, big and small, that come with a new home – from the square footage of the storage space to the height of the backyard fence.
But there are also potential pitfalls when building a new house. Here's what you should know:
Advantages of building a house
Retrofitting an existing residence can be expensive. A major benefit of the new build is that you can customize it to suit your tastes and family needs, from layout to location.
When building a house, you can put it where you want it and create the environment you need.
A new house will also be equipped with the latest features such as energy-efficient materials, technology-friendly cabling and security systems.
And you have almost complete control over the building materials used in your home, as well as the cost of building a home.
Your builder selection is probably the most important decision you will make. So don't enter the relationship lightly.
That said, you can make both aesthetic choices (like hardwood vs. carpet) and practical choices. For example, you could avoid toxins in the materials and make the indoor environment safer for you and your family.
Adding Energy Star or eco-friendly appliances will not only make your home environmentally friendly but also make your home energy efficient, which will reduce running costs. You can choose to invest more in some areas of the home and less in others.
Building your own house offers other financial advantages:
You don't pay for premium features you don't want, like a finished loft or carpeting. You may get better value for money as you get the layout you want. Maintenance and repair costs are low for the first 7 to 10 years. Minor repairs are covered by your home warranty, and you usually have a one to ten year manufacturer's warranty
There are probably no unexpected negative surprises with choosing the right builder or contractor for your project and getting your home built the right way.
Your builder selection is probably the most important decision you will make. So don't enter the relationship lightly.
Cons of building a house
Building a house can be complicated. It can disrupt your lifestyle.
What if the timing is wrong and you are selling your current home but have to wait a few more months to complete your new home? You may need to store everything and find temporary accommodation.
Home construction projects are prone to:
Delays in improperly structured contracts Delays in changes to the construction plan Cost overruns Weather delays Delays in late delivery of materials
Good planning can help avoid many of these problems, but others can arise unexpectedly.
For example, after Hurricane Katrina, the cost of building materials rose – something you wouldn't necessarily predict.
Botched or delayed custom-made products are not uncommon. And if a contractor or subcontractor doesn't follow the latest blueprint, the effect can be disastrous.
As long as the defect is not as large as incorrectly installed load-bearing walls, it can be repaired, but it is usually not free.
Sometimes builders or general contractors hide or cause construction defects. There may be home warranty issues that you are unaware of. If your manufacturer's or house warranty does not cover these defects, you may incur high costs to fix problems.
Buying fixer upper: a happy medium?
One way to divide the difference between buying and building is through redevelopment. That means you buy a house with lots and lots of foundations and finance your renovation work directly with the purchase.
You can do this with one of several products:
The FHA 203 (k) loan The loan amount is based on the property's improved value and only requires a 3.5% reduction for most applicantsFannie Mae HomeStyle Mortgage enables you to finance second homes and rental homes as well as main residences. Deduct only 5% if your income is low to moderate, this is it HomeReady Loans With just 3% off and flexible underwriting, you can get Freddie Mac's home renovation mortgages similar to Fannie Mae's products. However, the guidelines vary, so you might get approved for one even if you're rejected for another
As with any mortgage, it pays to compare offers from multiple lenders.
Building a House: The Bottom Line
Homeownership has many advantages, whether you are building or buying.
It takes a strong team to build your own home. Your builder and your lender will be important members of this team. You can make your dream home a reality.
Choose your builder and lender carefully and you stand a great chance of building the home you want within your budget.
Check your new plan (May 14, 2021)