Financing the construction of any new home takes careful planning. But financing a new custom home is a little more complex. The reasons for this are simple but deserve consideration. For a start, an architect, engineer, and a construction team all have to work together to create custom features that meet your needs and ideals. With a custom home build, unexpected setbacks will sometimes arise which can lead to design revisions and the use of alternate materials. These setbacks can add time and cost to the project, and that can be difficult to budget for. This means it is a good idea to build in some room for error in your original budget.
In most cases, the process comes in three phases, financing the land, financing construction, and finalizing a construction loan into a permanent loan. Now, because building a custom home is always somewhat uncharted territory, there are pitfalls to watch out for and common mistakes to avoid.
HOW TO FINANCE A CUSTOM HOME & COMMON MISTAKES TO AVOID
Because it can be more difficult to get approved for a new home build than a loan on an existing home, it is important to follow the right steps to help reassure your lender. Since there is no existing asset to use as leverage, the lender has more to lose. But with a decent credit history, and by following our guidance, you’ll be on the right track.
Financing the Land
Some custom home builders will own lots that they hold in reserve for prospective buyers, but most do not. Either way, you will need to buy the land before obtaining a construction loan. If your builder owns the land it can be bundled into the construction loan package, which is more convenient.
Most banks offer land loans, but not all. Keep in mind that many custom home builders also offer in-house financing and may work with you to combine the cost of the land with your build. You will want to compare the terms of the different financing programs available to obtain the best deal. Custom home builders that do have in-house financing may incentivize you to work with them on this part of the project. Also, it will be more convenient to have the entire project financed through a single channel.
A common loan structure you will encounter through credit unions will look like this:
- Loan to Value: 75% to 80%
- Down Payment: 20% to 25%
- Interest Rates: 1% to 2% above prime
Smaller banks are usually the best places to go for these types of loans. Lenders that prefer them are very fond of these types of loans, but they can be tough to find. Again, it might be best to choose an in-house option with your custom home builder.
They are usually structured as follows:
- Loan to value: 80% to 90%
- One-year term: Short-term, since you refinance after construction is completed
- Down Payment: 10% to 20%
- Interest Rates: 1% to 2% above prime
It is best to plan well ahead for your monthly loan payments which you will make during construction. Bear in mind that these will be small at the beginning of the process and grow each month as the balance comes into parallel with the progress of the build.
Closing a Construction Loan
After the construction is finished, your loan will be converted into a permanent loan. This is where the financial services you obtained to obtain land, design, and build your home become more like a mortgage. You can refinance or you can combine the construction and permanent loans into a single “one-time-close” loan.
Most banks offer 10, 15, 20, and 30 year fixed premiums as well as a list of adjustable-rate packages. Do take the time to review the terms of all the available financing packages before signing on the line. Do not be afraid to take your time to do this, especially since lenders who might take advantage might view impatience as a sign of vulnerability.
COMMON CUSTOM HOME BUILDING MISTAKES TO AVOID
Building a custom home can feel like a dream come true. At the same time, those starry eyes may become blind to some common pitfalls.
Settle Details Before the Build Begins
Things will change during construction. That is a common feature of custom home building. Still, do your best to get all the details hammered out before your team breaks ground. It will minimize guesswork and ease communication.
Do not Overbuild
In designing a custom home, it is easy to go overboard with all the possibilities. Focus on the features you will use and appreciate most before indulging in a large amount of “bucket-list” items.
Leverage Financing Within Reason
It can be easy to take a bigger loan than you are prepared to handle, especially with a custom home. As mentioned above, there is a possibility of engineering setbacks, design changes, and a need to use alternate materials. This will cut into your budget, so you should be prepared to fund your way through them.
Check on Work Progress
It is a good idea to check in with the progress of your build at least once a week. This is your opportunity to make sure things are going to plan. It is also a chance for the foreman to talk to you about any concerns he may have.
Keep Your Feet on the Ground
It’s easy to let your head drift in the clouds when daydreaming about your dream home. Just don’t let your dreaming get in the way of being practical, sensible, and most especially – staying under budget.