In plain English, how does construction financing really work?
When clients come into our offices they have all kinds of ideas on how construction financing works. Construction loans, permanent loans and single-closing construction-perm loans are all possible options. And while they all work the same during home construction, they vary greatly at the beginning and the end.
First, let's see how they are the same.
With any type of construction loan, your payments during the building of your home are fairly small. That is because they’re not based on how much you’ve borrowed, but just on how much the bank has paid out up to that point. For example, let’s say you own your land and the cost of building your new home is $200,000. When you close on your loan, you haven’t really borrowed any money, it’s just been made available. Your builder is paid in instalments or “draws”, based on the amount of work that’s been done on your home at each stage. For the first “draw”, usually banks will pay the builder 10% at the loan closing, or 15% when the foundation is finished. Thus for your first payment 30 days later, you’ll be paying the interest on only a small percentage of the total loan - just on the amount that so far the bank has actually paid out to your builder.
For instance, in the above example if your builder is given a draw of $20,000 at closing, then one month into construction you would have a payment of about $83, or 30 days interest on the $20,000. Of course as construction goes on, and the money drawn out increases, likewise your payments also increase. This is why it is so crucial that construction remains on schedule – not just for your family, but for your finances as well.
Now, let’s take a look at how they're different.
The biggest difference between the types of loans available is in the closing costs, legal fees and other costs associated with the bank process and the recording of your loan. For example, if you have a construction loan and a permanent mortgage, which is typical, you’ll have two sets of closing costs. Individually each set is not usually as high as those of a standard mortgage - so you won’t be paying double -, but the total of both together will be somewhat higher.
A few Virginia banks have started offering single-closing construction-perm loans, which have been standard in other states for a number of years. With this type of loan, you only have one closing, at the beginning of construction. When the home is complete, the loan simply “modifies’ into your permanent mortgage, thus saving you the second set of closing costs. The closing costs will almost always be higher than for a construction loan, but rarely as much as the total of the two closing costs of the two-loan method discussed above.
Depending on your individual circumstances one method or the other may be better for you.
If you’d like more information on how each loan-type works, on the financing process in general, or some unbiased feedback on what specific area banks offer, please give us a call or send us a note here.
Often, by the time clients receive our brochure, they have already found a plan they’ve fallen in love with. Whether it’s something they found online, something they’ve had drawn, or a plan they’ve created themselves, we can usually figure a cost to build the home on their property. For a custom builder, pricing that home is a costly, time consuming process. It’s very common for clients to tell me that they’ve gone to other builders, but never received any final pricing. There can be a few reasons – the builder may be booked up for the year, the plan may be more complicated than they want to take on, but it’s usually just that it’s going to take them too much time to price. Here are a few tips that will help you get better results when looking for custom home pricing.
Finally, if you’re understanding the complexity of what the builder has to do – estimating all the pieces and parts that go into a plan, estimating the cost of labor to put all those pieces together and estimating cost increases over 8 months – you’re going to have varying, sometimes widely, prices. Because a builder happens to be the highest price on your home doesn’t mean he’s a “high priced builder”. His estimating on your plans may have just come out higher (or everyone else is low) because none of them have built the plan before and none know the cost for sure. So a word of warning, prices will always vary regardless of overhead or profit margins because everyone is estimating. If you have two estimates at $275,000 and one at $225,000, STEER CLEAR! Of the fifteen to twenty homes we build each year at least three are for customers who had a contract with a builder and it never got started (after a long period of time and a lot of money paid to the bank) because the builder realized he couldn’t build it for the price he quoted. Last year was out of the ordinary. We had six, nearly a third of our customers, who came from another builder who didn’t deliver. My best advice, which I give at all First-time Homebuyers Seminars that I do for builders in Virginia, is that price is undoubtedly important, but reputation is the only thing you can count on. Unfortunately, it’s impossible to compare apples with apples because there are a hundred places for a builder to reduce cost that you’ll never, ever know to ask about. Ask for references from recent customers, check reviews, talk to local banks to see if they’ve had issues. In short, do your homework to find out if the builder has a reputation for delivering on time and on budget. You would do it before you buy a car, do it before you make the biggest investment of your life.
If you would like to talk with one of our highly experienced building consultants about finding the right lot and a free site inspection, building your new home or how financing works, please give us a call in Lynchburg at 434-266-1070 or Smith Mountain Lake at 540-912-0112.