Financing QuestionsHow do I know where I should build my home?
Location may be one of the most important factors to consider. Although many people have geographic location in mind, some are open to alternatives. It is important to consider your lifestyle as well as the cost. If you are planning a family, schools will be important. If not, you may want to consider other factors such as proximity to work, or accessibility to the beach, the mountains or leisure activities.
Once you have selected the area, you will need to select a lot for your future home. There are real estate agents who specialize in finished lots as well as individuals and companies that sell individual finished lots. A finished lot is a potion of land that already has road access and utilities in place. Additionally, the land has been approved by the city or county as a separate parcel of land on a parcel map.
I've selected a site, and have my plan. How do I know who is qualified to build my house?
You will want an experience builder with a history of delivering a high quality finished product within budget, in a prescribed time period, and in a lien-free condition. If licensing is required in your state, you will want to verify that the builder has the appropriate license for the planned work.
Word of mouth from friends, family, and others is one way to get in touch with the builder community. Once it is known that you are building a new home, you may find yourself inundated with individuals who want to build your home for you. You may receive several bids. Remember that the lowest bid is not always the best deal. Make sure you are comparing the same materials and the same amount of time for completion of construction. Also note when scheduled payments to the contractor are due.
If licensing is required in your state, be sure to select a licensed general contractor with a history of building the type of home your plan has be designed for. Ask for a copy of his or her license and check it with your local licensing authorities or governing board, if your state or community has one. Ask for references, including a list of supply companies with whom the builder has done business, and individuals for whom he or she has built similar homes.
Don't be afraid to ask. After all, you're interviewing someone for a job that will, by necessity, last until the house is completed. A reputable contractor should be more than willing to discuss the project and provide the requested information. You may also want to ask what kind of insurance the contractor carries (for example, workers' compensation or, general liability insurance).
It's a good idea to check references from both the construction industry and from homeowners for whom the contractor has built homes. The builder's suppliers (companies from which the builder has purchased materials) can verify if your prospective builder is eligible for lines of credit to order materials. Check to see that the houses the builder has completed were completed on schedule in a lien-free condition and that the owner is happy with the quality of construction.
Once you've narrowed your list down to several builders, you may wish to take bids. Make sure every builder asked to bid a job is provided with the same complete set of plans and specifications so that he or she can create a complete bid. If you provide an incomplete list, guarantees to finish a job for a certain dollar amount may be of no value. Additionally, consider the time it will take to complete construction guaranteed in the bid. If you borrow funds, a job finished early may save you interest on borrowed construction funds. On the other hand, if you exceed the construction time period allocated on a construction loan, you may be subject to extension fees as well as additional interest costs.
Are there any other costs associated with the construction of my home?
A fixed price contract should take into consideration all materials and labor. You should read it thoroughly to be certain you know what's covered and what's not. The contract may only include on-site costs (construction materials and labor) for a project. Off-site costs should also be taken into account, the plan price, engineering fees, soils reports, city or county permits and fees, and builder overhead/supervision.
In addition to the contract price, it is common for a construction lender to build a contingency reserve into the loan. This is a specified percentage or dollar amount usually required by the lender in case of unforeseen circumstances that could negatively impact construction of the home. The amount required is usually based on a percentage of the contract price, on-site costs or loan amount. You should ask your lender about its policy regarding funds that remain unused after the construction of the home.
Additional costs include any construction loan closing costs and fees and special insurance requirements. These will vary and should be discussed with your construction lender. There are now Construction-to-Permanent Loans that include on-site costs, off-site costs, closing costs, interest reserve, contingency reserve and lot purchase or value.
When will I have to make loan payments?
Depending on your construction lender, you may not have to make any payments out of pocket during the construction period at all. Your lender may incorporate an interest reserve within the loan amount. Depending on how quickly you use your construction funds, there may be sufficient funds within the construction loan to carry you through (or almost through) the entire construction period. A Construction-to-Permanent Loan may include an interest reserve in the loan. Of course, if you use the money faster than expected, you will have to make some payments from your own funds outside the loan during the construction period.
Will the payments on my construction loan include principal and interest?
Not necessarily! Your construction lender may allow payments of interest only until the house is completed. Generally speaking, interest is charged only on the amount of funds used. You will want to verify this with your construction lender.
My friends obtained a single-close loan and they said that's what I should get. What is a single-close loan?
A single-close loan is a loan that encompasses both the construction period and the permanent loan. Until a few years ago, if you wanted to build a new home, you had to obtain two loans: an interim construction loan to get the house built and a long-term traditional mortgage loan afterwards to pay off the construction loan. When there are two separate loans, often with two separate lenders, it is necessary for the borrower to qualify twice: once before the construction loan and again before the long-term loan. Additionally, there are two sets of documents and two sets of closing costs.
What will my construction lender need in order to review my loan request?
Remember, you're asking the lender to loan you money on your dream. Your lender will need to see that dream as clearly as you do. Therefore, in addition to standard credit documentation, your lender will want, at a minimum, copies of the following to start the process:
1.0 Final plans and specifications. These are needed in order to obtain an appraisal.
2.0 2. Purchase contract for the lot (or Settlement Statement if you've already purchased it)
3.0 Property Profile (Description of Materials)
4.0 Line Item Cost Breakdown from the builder
5.0 Builder's construction contract
6.0 Copy of builder's license
7.0 Builder's statement or application
Keep in mind that you need to obtain the necessary building permit for your community.
Does the construction lender really need all this information? Why do they need information on the builder?
Yes, the construction lender really does need all this information, and sometimes more. Because they're a key player on your team, as well as an investor in your dream, they will want to do their own research on the project and on the builder.
Does that mean the construction lender will take responsibility for watching the job for me?
No, the construction lender does not assume that responsibility. You will need to monitor the construction of your home and make sure it is completed to your satisfaction. If you have selected a reliable builder, your job will be a lot easier.
How will I get money from the construction lender? Is it given to me at the time I sign the loan documents?
Generally, a construction lender will not advance funds for the construction of the home until certain key events occur. Usually, some work must be completed before the lender will advance any funds. Therefore, you or your builder may have to pay for some materials and labor up front to get the construction started before you will be able to obtain any funds for reimbursement from the lender. Some lenders may require copies of paid receipts, lien releases (also known as lien waivers) and site inspections.
Others may base disbursement of funds on work completed as evidenced by site inspections and title company endorsements, assuring them that the property does not have any mechanic's liens filed against it. Still others may offer a joint check system, which permits the borrower to issue checks but requires the lender's co-signature prior to payment. Be sure to ask your lender how they disburse funds on a construction loan.
Is there a way to use the equity in my existing home as down payment on my dream home?
Yes, you may obtain a Bridge Loan. This enables you to use the equity in your home as the down payment on a construction loan. And during construction, there may not be any monthly mortgage payments on the Bridge Loan. This lets you live in your existing home while you're building your dream home. Typically your Bridge Loan is not due until your new home is finished or you sell your existing home.
What if I get the construction started and decide to change something in the plans or specifications?
Since your loan, permits and construction contract are all based on the plans and specifications submitted in your loan package, you will need to obtain approval for any changes with your architect, lender, the city and/or county planning department and the builder. Depending on the extent of the changes, if approved by all parties, you may be required to make security deposits and/or pay additional funds before continuing with construction.
Can I start construction on the house from my own funds and credit cards and then go to a construction lender if I run out of money?
Unless you're certain that you can build your home totally from your own cash reserves, it is generally not advisable to start construction on your own. If you do start and run out of money, you may have difficulty in getting a construction loan. Several reasons (though not all) are as follows: First of all, your contractor may have difficulty in getting materials delivered on anything other than on a cash basis, as material suppliers are unable to verify funds through a construction loan. He or she may have similar problems with subcontractors wanting advance payment for work that would otherwise be billed in increments or at the end of their work.
If you do find that you need a construction loan, normally your construction lender would require that the collateral for the loan be a first mortgage, insured by the title company to be lien-free. This means that if work has already started, the title company may not be willing to insure the loan in a lien-free condition.
If the title company does agree to insure title, it may first require copies of your construction loan package including, but not limited to, your personal financial statements, plans, cost breakdown, contract, information on the contractor, and lien releases. Upon review and approval, the title company will generally require that you and your contractor indemnify them against any mechanic's liens.
In addition, your construction lender may be reluctant to place a loan against your property without having had the opportunity to inspect it during the earlier stages of construction (to be certain those items that are no longer visible meet the specifications of the plans).
This is for the lender's protection and does not take the place of any city, county or state building inspection requirements.
Furthermore, if you use all of your funds to build your house, you may not have the reserves required by your construction lender to qualify for a loan should you discover you need one.
Finally, if you have used your credit cards to pay for construction, most construction lenders do not provide for the payment of credit card debt through a construction loan. Consequently, you could be stuck with credit card debt at a higher rate of non tax-deductible interest than your construction loan would have provided. Generally, it is much safer not to start construction (or "break ground") or even drop materials on the lot until the construction loan has been funded through your closing agent.
What do you mean when you say, "break ground?"
This is a common construction term that refers to the start of construction. Think of a shovel touching the dirt to prepare the land for construction. This may include even simple tasks such as clearing shrubs, weeds, trees, or dropping soil on the site. Any such work constitutes "breaking ground". Any work started prior to the recording of the construction loan constitutes what is called "broken priority" and may create obstacles or delays in the loan closing.
"Broken priority?" What does that mean?
This is another industry term. It refers to starting construction or breaking ground prior to obtaining construction financing. Again, remember that most individuals get their construction loans recorded first and then start construction.
What is a closing agent?
Depending on your geographic location, your closing agent may be an attorney, a title company or an escrow company. This is the person (or entity) who assists you in signing loan documents, recording or filing deed transfers and mortgages, ordering title insurance and coordinating the exchange of funds.
Since there are differences in how a construction loan is documented and closed, you should select a closing agent with experience in construction loan closings. The agent's experience and expertise can simplify the process.
You mentioned financial planners and insurance agents as part of the construction team. What role do they play?
A financial planner or tax accountant may be able to offer you advice on any tax benefits available. This may include suggestions on when to build and whether or not you should sell your current residence. It may also include information on where to build and what materials may offer you tax advantages.
Likewise, an insurance agent may provide you with information about any insurance benefits available for utilizing certain materials, as well as geographic considerations. In addition, the insurance agent can start shopping rates to obtain those special insurance coverage's that your construction lender will require, such as course of construction (builder's risk) insurance, personal liability coverage and general liability coverage.
I never realized there were so many considerations and people involved in building a home!
Yes, there are a number of considerations, but you have the advantage of being able to select experts for your team. Consequently, you can build the home that not only fits your needs and other practical requirements, but also meets your aesthetic and visual expectations - your dream home!
Borrower's Checklist
Okay, so you've selected your community, your lot, and your architect. You've got a terrific set of plans, and you're ready to build. What about construction funds? Have you selected a lender and considered the documentation they will need to make a lending decision?
Take a moment now to look over the list. Obviously, the sooner you get the complete set of items the sooner you can start construction. Please note that though the second group of items your contractor will give you, you'll still need to collect these items and assemble them to complete your loan package.
Items to get from your Contractor:
Insurance Requirements
Now we've come to another important requirement, and that's insurance. When you're building a home, you have risks that you wouldn't normally have on a home that's already built. Therefore, you and your lender will want protection from those risks. While insurance requirements vary for different types of loans, the following are some examples of insurance you may need during the construction of your home.
1.0 Course of Construction Casualty Insurance. This is an "all risk" policy covering fire, extended coverage, builder's risk, replacement cost, vandalism, and malicious mischief. As the owner, you would be the named insured, with the insurable value equal to the replacement cost of the improvements or the loan amount, whichever is lower. The lender is also named as an additional insured. Once the improvements are completed and the permanent phase begins, the course of construction policy is usually converted to a standard "all risk" homeowner's policy.
2.0 Worker's Compensation Policy or endorsement that covers the contractor, subcontractors and others who will be working on property. The contractor usually provides this policy; therefore, the contractor should be the named insured. In states where workers' comp is not required, or if you're acting as your own general contractor, a waiver of this insurance is required to be executed.
3.0 General Liability Insurance in the form of a comprehensive general policy or included as a broad form liability endorsement. You or the general contractor can typically provide this policy.
4.0 Flood Insurance. You may be required to have flood insurance if your home is being built in an area that the federal government has identified as a Special Flood Hazard Area.
5.0 Lot Loans. You may want to look at your existing homeowner's policy for liability coverage that can be extended to cover the lot you're purchasing. If you're purchasing a lot now but won't be building yet, you may want to consider a Lot Loan. This is short-term financing for the purchase of a residential lot suited for the future construction. This loan allows you time to select an architect, builder and find a design for your dream home.
Glossary
All-In-One Loan - Some enlightened construction lenders are offering combination loans that you close on only once. When you finish construction, the long-term mortgage automatically kicks in and pays off the construction loan. These loans save on origination and some other fees.
Buildable Pad or Building Pad - A generally level land site with soil compressed to support the weight of all construction improvements.
Building Permit - Written authorization issued by a local governing body, such as a city or county planning department, which authorizes the construction of a building. A permit is obtained prior to any your construction or remodeling on a specific site.
Cost for Inspections - Lenders want to have the project inspected periodically to see that the work they pay for has been done. Some lenders insist on an inspection before every draw, and make you pay for the inspections. Most lenders have a program of periodic inspections. Some lenders charge nothing for inspections; many, however, do.
Disputes - What recourse do you have if there is a disagreement? Our loan was tied up for a month late in the project because the bank insisted that we had spent 92% of the funds but that the project was only 87% complete. We had subs that wouldn't do more work until paid, but the bank wouldn't advance a nickel. It turned out that their computer spreadsheet had a totaling error and they were off by six percent. We had no way of getting their attention in the meantime.
Greenbelt - A dedicated area planted with grass, foliage, flowers, shrubbery. In planned communities, a community homeowners' association generally maintains greenbelts.
Insurance Cost - Some lenders have arrangements with various insurers that could save you money on course of construction insurance.
Lien-Free - Without encumbrance (or liens) against a specific property.
Lien Waiver - A release of mechanic's lien rights, usually signed by the general contractor, subcontractors or material suppliers.
Loan Rate - The interest rate could be fixed or adjustable, and pegged at some percentage over prime. Adjustable rates are less risky for the lender and more risky for you.
Mechanic's Lien - An encumbrance against property for payment of work or materials supplied.
Origination Fee - This fee can vary from zero percent of the loan amount to as much as three percent.
Plans and Specifications - Architectural drawings showing the foundation plan, floor plan, exterior plan, including all dimensions, design and structural requirements. While additional cosmetic features may be included, the concentration is on the shell and physical structure as opposed to such features as the type of wood used in the cabinetry or siding of the home.
Property Profile - A list of materials to be used in the construction of a home, including design amenities (such as type of wood to be used in cabinetry or siding of the home) and the structural requirements.
Site Inspections - Physical inspections of the property conducted by cities, lenders, title companies, or other assigned individuals to review project status, quality or legal infringement upon other individuals' property rights.
Time Limit - With most construction loans, you get a loan on which you make no payments. A construction loan accrues interest as time goes by, and that interest is usually paid off by the long-term mortgage on completion. How much time will they give you before the loan is over and you must make interest payments? Six months is common, but very optimistic since the average owner-built house takes longer to build. Many banks give nine months on a custom home.
Title Company Endorsements - Specific insurance coverage added to a title policy for the benefit of one or more parties to a transaction. Each title company and state has a standard list of commonly used endorsements, which may include such things as assuring a lender that the property has no mechanic's liens filed against it or that the foundation location is not in violation of any legal rights of public record.