To Build or Not to Build, That is the Question! – Part II
In the previous segment, several options were discussed that are available to you as you consider whether to purchase or build a new home. In this next segment, I will discuss some of the important options to consider if you have decided to build.
With your builder selected and your plans determined, it will now be time to arrange for your interim construction financing. You have a couple of options:
- #1: You may consider allowing your builder to handle the interim financing and then sell you the finished home upon completion. Under this scenario, you will only need to apply and pre-qualify for the permanent mortgage loan to purchase the finished product and will not need to bother with an interim construction loan.
o This may prove to be a better alternative than a bridge loan, etc. in that you will have more time to sell your existing home should timing be an issue. However, under this scenario, depending upon your pre-qualification requirements, selling your existing home will most likely still be a necessity prior to closing on the new home purchase. Consequently, determining the marketability (physical condition) of and the market conditions for your home must be considered. You do not want to have the situation occur where you must close on the purchase of the new home and be delayed or unable to sell your existing home.
o Under this option, the residential lot to be built upon will need to be in the builder’s name. This may be a good option if the builder already owns the lot you like or has ready access to a desirable lot. However, should you already own your lot, there are a couple of options, both of which include your allowing the builder to have control over the lot; either by you pledging/collateralizing it to the builder under standard Mechanics and Materialmen’s Lien documentation or transferring it to the builder under a standard Warranty Deed.
- #2: You may elect to carry the construction financing yourself and pay the builder as construction progresses. Under this scenario, you will need to obtain interim construction financing as well as getting pre-qualified for your permanent mortgage loan. Generally, your construction lender will require that you be pre-qualified for your permanent mortgage loan upfront in order to assure your ability to roll the interim construction loan into permanent financing at completion. This may be the same lender in both cases, but can be two separate lenders or lending institutions – one for each type of loan.
Assuming that you decide to obtain interim construction financing which you arrange and carry, your construction lender will need the following information:
- Interim construction loan application, along with at least 2 years of tax returns. (This would also include business tax returns if you are self-employed.)
- Evidence of your pre-qualification for your permanent mortgage loan.
- A detailed cost breakdown, including the cost of the lot. (Cost breakdown to come from your builder.)
- A set of plans. (Your lender will order a residential appraisal based upon the plans and specifications of your home.)
- Your lender will order a site survey. (This may be done at completion provided there are no obvious boundary issues with your lot.)
- Your lender will need to know where your equity injection will come from - cash on hand, sale of prior home, gift from family, or other sources.
You will need to plan on providing at least 15% equity for an interim construction loan – 85% loan. Should your plans be to have a larger permanent mortgage loan at completion than the 85% construction loan, say 90% to 95%, you can consider pledging additional liquid collateral, i.e. Certificate of Deposit, behind the construction loan during construction in order to meet the necessary equity requirement of 15% . This will enable you to establish the interim construction loan in the amount you wish to carry into your permanent mortgage loan. In Texas, the interim construction loan amount must establish the maximum amount of the permanent mortgage loan, so this topic should be discussed with your construction lender.
- You will generally be required to pay interest monthly during the construction phase. This interest amount will be based upon the outstanding balance on your construction loan from time to time and consequently, will grow as the loan advances up. The benefit of this is to spread this interim financing interest cost over the construction phase rather than paying it as an additional lump sum along with the other regular closing costs requirements of your permanent mortgage loan closing.
- Your lender will generally require that you open a new DDA account, specifically for handling the receipt of loan advance deposits, equity injection deposit(s) and checks drawn by you to pay your builder’s periodic draw requests. This also enables you to have a concise record of the construction costs of your project, which will be needed for your permanent loan lender.
- You, the owner, should be the one to pay your builder for each draw request. This is best in that it proves that you approve of the status of the construction progress. Your lender will monitor advance rates to completion percentages of the project as well.
These outline some of the more important items you will need to consider as you plan to build your new home. It is also very important to counsel with your lender as you contemplate your construction project. If you do not currently have a banker, try to choose a lender who is experienced with residential construction and will therefore be able to help guide you through the process. This should enable you to have an enjoyable and rewarding construction experience.