Right now, in many housing markets, demand is outweighing the supply of existing homes. When this happens, more potential buyers turn to building to obtain their desired housing needs. The process of acquiring land and building a home can seem like a daunting task, but it doesn’t have to be dreaded.
A well-thought approach to the building process can reduce delays and prevent disappointment.
The second habit in Dr. Steven Covey’s book “The Seven Habits of Highly Effective People” is to begin with the end in mind. At the end of the home building process, home builders will be living with a mortgage payment or the cash outflow attributed to the home build. Unless they have unlimited funds, start with the budget.
If financing is required, working with a lending professional that specializes in construction loans is an important first step. Not all lenders offer construction loans. There are a few lenders that will bundle the purchase of the lot with the construction cost of the home together into a one-time close loan that will quickly convert to a final 15- or 30-year loan upon home completion.
A one-time close eliminates the need to have a closing on the lot loan, a separate closing on the construction loan and a third closing on the final 15- or 30-year loan. This greatly reduces closing costs required and simplifies the lending process. This works best if starting the home construction immediately after obtaining the lot. It does require more homework upfront as the construction contract will need to be finalized with the builder before starting the loan process on the lot.
The same is true if a home builder already owns the lot and needs a construction to permanent financing loan. A few lenders can do a one-time closing on the construction loan, and when the home is completed, the construction loan converts to a 15 or 30-year loan for the duration. Of the lenders that offer the one-time close option, most allow locking in a 15- or 30-year loan interest rate six months to a year in advance with the option to float down if rates drop. This adds more certainty to the monthly interest expense a home builder will pay once the home is complete.
Construction loans are different from obtaining a loan on an existing home in that most lending institutions will only extend 80% loan-to-value – the amount of money borrowed as a percentage of home value – versus up to 100% in the case of existing homes. This means a home builder will either need to have 20% equity in the lot and house combined, pay cash for the remaining 20% or a combination of the two.
The home value is determined by an appraisal. In the case of new construction, the appraisal is obtained upfront, before construction, and is based on the land value and proposed home value combined. The appraiser uses the floor plan drawings and home specifications in the contract to come up with a proposed value.
Finding a lender experienced and knowledgeable in construction financing will ensure this first step in the building process is a smooth one.