Financing Your Dream Home Lot
Once you have made the decision to build your “Dream Home” the first step is to decide which lot to build upon. Your builder of choice may have an inventory of lots for you to choose from or he/she may help you negotiate for a lot in a neighborhood of your choice. If this option is not available, driving around the neighborhoods and inspecting the available lots is an option. You'll want to write down the phone numbers and Seller information from the posted signage. You can then take this information to a Builder or a Real Estate Agent to help you in put in a Contract for Sale. If there is no signage, the Real Estate Agent or Builder can help you find out information about the availability of the lot(s).
The next step in the process once you have decided on your lot (before you execute a Contract for Sale) is to decide if you will begin building immediately after your plans are drawn or are you going to hold the lot for a period of time to build at a future date.
The information I am discussing in this blog is the financing arrangement for purchasing and holding a residential lot for a building project in the future.
Many people wish to purchase a lot and then hold it to get it paid for before building, hold it until they are able to sell their existing home, hold it until a future event provides them more cash or earnings power, hold it to see how a subdivision develops, etc.
Options to reduce the risk in the project of building a home.
Down Payment: As with any fixed asset financing (i.e. – land, homes, cars, equipment, etc. ) banks require a down-payment (“Equity”) when purchasing these types of assets. On a residential lot held for future construction of a home, the down-payment requirement is typically 20% of the purchase price of the lot. This 20% Equity, plus the normal closing fees for surveys, appraisals, legal fees, title work, filing and other small closing fees, will be the cash you are required to bring to the closing of the purchase. The 20% cash equity will qualify later to be netted against any down-payment requirements for your future home building project as long as no deterioration in the value of the lot occurs during the holding period.
Term (Maturity): Most lots, being real estate, carry the ability to extend the loan’s maturity over a longer period of time. Typically these loans can be financed up to a 15-year maturity or amortization period, however most of the time 5-10 years is ample for the purchaser. As with the down-payment above, the 20% initial cash equity plus any principal amount paid on the lot loan is your savings account to be used to reduce the down-payment requirements needed during the home building phase.
Purchasing and then holding a lot for a future home building project provides you a lot less initial cash down-payment and allows for an extended time frame for building additional cash equity to begin the home building process. It also reduces the risk of starting a new home project not having sold an existing home and having to support both the existing home loan (or current rental rate) and the new home loan at the same time. This method can mitigate significant risk due to possible weak or extended sales conditions and additional cash and earnings requirements that are created.
My next article will assess the risks and provide information and options to you for purchasing a lot when your plans are to start immediately on your “Dream Home” project.