Construction Loans: Making Your Dream Home a Reality
Most people have thought of building their own home at one time or another. Besides allowing maximum control over the project, it can also be very profitable. But how does one apply for a construction loan and prepare for the project?
A major factor influencing financing is qualifying for the loan. The vast majority of people fail to check their credit on an annual basis. They usually discover errors in their credit report only when they apply for new credit. Most construction lenders need a minimum 620 credit score to secure financing. So before searching for lenders (and allowing them to run your credit) verify all the information is accurate in your credit report. If there are inaccuracies, this will be a great opportunity to rectify them.
In many instances, lenders are hesitant or inexperienced in financing these loans. Making a call to the local bank about financing the construction of your “not-yet-built home” will often be met with "Huh?" Road blocks such as this often discourage people from taking the first step. But in reality, construction loans are not that difficult to assemble – for the right lender. There are banks that specialize specifically in construction loans. A quick search on the Internet will produce a list of quality lenders who can finance your project.
While all of this is going on, you will also want to investigate the land and real estate values in your area. Lending is based off of appraised value. So if you are over building for the area, lenders will be hesitant to extend credit. Visit neighborhoods and developments in the area to see what homes are selling for. This will not only help qualify you for the loan, but it will also help you pick a building lot and home plan – which leads into the next topic.
Home plans are crucial to the process. Once you have qualified for the loan and found a lender, the bank will require you submit plans for an appraisal. The Internet has an abundant source of home plans available for your project. It is common for stock plans to be modified, so there may be an architect involved in customizing your plans. The lender will require a set of these plans to perform an appraisal. An appraiser will take the home plans and estimate the value of the home if it were completed. This will determine your Maximum Loan Amount – or MLA (coupled with your credit score and assets). Home plans do more than show the construction of the home – they will be used for bidding by material suppliers and contractors. Often times, the more elaborate the plan, the more expensive it is to build. It is important to keep this in mind because if the cost to build the house exceeds the MLA, the lender will not fund the loan.
So how does one pick a home plan which does not cause excessive labor cost issues? Home plans with complicated roof designs, elaborate floor plans, and expensive materials drive up the cost. Striking a balance between design and function is the key to succeeding in the process. Consulting an architect prior to purchasing plans will enable you to design or modify a plan that will work with the loan amount and construction cost. It is important to remember architects are not cheap – so choosing a stock plan close to your liking can save you money!
After this point, you will be closer to making your dream a reality! To recap, you should have:
- Checked your credit for any inaccuracies and rectified the problems
- Found a lender which specializes in construction loans
- Evaluated the local market for what the home would be worth when completed
- Chosen home plans (and had them modified if need be) so an appraisal can be performed
The next step is assembling your construction budget. A construction budget is made up of several key factors:
- Soft costs – permit fees, architect or engineering fees, HOA fees, etc
- Labor costs – contracted labor for site work, foundation, framing, etc.
- Material costs – lumber, roofing, siding, cabinets, plumbing fixtures, etc
You may find it hard locating contractors. Residential contractors tend to be do both labor and office work, so their time is limited. Do not be surprised if you run into delays receiving bids. The key here is to remain persistent! It is also important to distinguish the types of contractors to contact. General contractors specialize in building the entire home – and have a group of subcontractors who actually perform the work. While General Contractors alleviate much of the stress of building, they also charge a hefty price (usually 20% of the home’s appraised value). Not only does this put a strain on the financing, but it cuts into your potential equity in the home. The other option is to remove the General Contractor all together, and go directly to the subcontractors. By cutting out the middle man, you reap the benefits.
However, subcontracting the entire project is not without its costs. If you are building your own home – i.e. acting as the General Contractor – you assume all liability for scheduling, payroll, etc. It takes a lot of time and hard work to manage 10-12 subcontractors over a 12 month project. But why do it? Why take on this type of stress – especially if you have never built a home before?
The simple answer is equity. If you were to buy a home already built, your equity position would be minimal at best. Some people even find themselves owing more than the house is worth. If you plan on living in the home for an extended period of time, this is okay. But if you want to build more house for your money – AND have a valuable equity position, building your own home can be a profitable venture. As mentioned before, a General Contractor charges 20% of the appraised value as a supervision fee. If you cut him out, you turn that 20% into equity in your home. So, instead of starting off with little to no equity, you are in a favorable equity position the moment the house is completed!
Construction loans are arguably the most involved type of loans on the market. Many factors are involved – some of which you can control and others which you cannot. There are companies which specialize in financing and helping you manage the project. Searching the Internet will yield a handful of these companies. They charge fees for their services, but are usually less expensive than hiring a General Contractor. Their services can also be extremely helpful since they are providing the financing and helping you manage the project.
There are over 100,000 owner-builder permits issued a year – so you are not alone. The key to making this dream come true is preparation from start to finish. The catch is hard work and diligence, but the rewards are equity and satisfaction in building the home you want.
At Alpine Mortgage, we specialize in providing a variety of construction loans. If you have any questions regarding construction loans or are interested in applying for one, call us now at (800) 876-LOAN or click here to have one of our construction loan specialists contact you.