By Liz Pulliam Weston
If
you want to buy a home that somebody else built, you’ll have no trouble
finding reams of information -- and lenders -- willing to help you.
If you want to build your dream home, however, the road gets rockier.
Construction loans aren’t as easy to find, or understand, as a
traditional 30-year mortgage. Not
all lenders offer construction loans, and those that do vary widely in the
kinds of terms, rates and fees they offer.
Few
would-be homebuilders can do without a construction loan, however.
Only about one in five people who build a new house pays cash,
according to Census Bureau housing statistics.
So if your heart is set on creating a home from scratch, here’s
what you need to know about borrowing the money to start turning your dreams
into reality.
 |
The
all-in-one loan (also called the rollover or the
construction-to-permanent loan), which automatically reverts to a
standard mortgage after construction is completed, and |
|
The
construction-only loan , which comes due at the end of construction and
must be paid off or replaced by a conventional mortgage. |
Both
approaches have their fans. All-in-one
loans have one set of fees and one closing, reducing the hassles for buyers,
said mortgage broker Allen Bond of Palos Verdes Funding in California.
Although many all-in-one programs convert the construction loan to an
adjustable-rate mortgage, some plans offer 15- or 30-year fixed-rate
mortgages.
But
shopping separately gives consumers more choice, because they can select
from the thousands of conventional mortgage loans available rather than
being restricted to the mortgages offered by construction lenders.
This approach “lets the consumer wind up with the kind of loan they
really want for the long term,” said Ginny Ferguson, vice president of the
National Association of Mortgage Brokers.
What
you'll pay in rates and fees
In
either case, the interest rate you’ll pay on the construction loan is
typically fixed for the life of the loan -- usually 12 months or less,
although some stretch for 18 months. The
rate for people with good credit is usually the prime rate plus zero, one or
two percentage points. At the current prime rate, that means a rate of 4% to
6%. You’ll typically pay 1%
or 1.5% of the total loan amount in origination fees, plus several thousand
dollars in other fees to cover costs such as inspections (so the lender can
make sure the project is proceeding according to schedule) and title
insurance, which tends to be trickier with new construction.
“They
take a big chunk” in fees, says Warren Christensen, a Los Angeles
homeowner who recently paid $17,000 in fees to get an all-in-one
construction loan that replaced his mortgage and provided him $135,000 for a
major remodel and addition. “The
beauty of (the all-in-one loan) is that you’re not paying fees again when
you roll over, but it’s still a lot of money.”
The
higher cost reflects the risk of lending on an asset that hasn’t been
built yet. There are also fewer
construction lenders than there are mortgage lenders, so the market lacks
the kind of cutthroat competition that has helped drive down costs for
regular home loans.
Christensen,
a publisher who with his architect wife has built or remodeled several homes
in Los Angeles, recommends shopping around to get the best deal.
“Go to a bank that does construction loans and to a mortgage
company,” Christensen said. “Go to three or four different places, because rates can
vary greatly."
Construction
loans also differ from mortgages in that they don’t pay out all at once.
Lenders typically dole out your funds in five to 10 “draws” timed
to various stages of construction, such as:
|
Grading
the site and pouring the foundation |
|
Framing
the house |
|
Installing
heating, air conditioning, plumbing and wiring |
|
Finishing
the exterior |
|
Installing
drywall or other interior surfaces |
|
Installing
cabinets, fixtures and trim |
|
Interior
painting and other finishing touches |
The money is typically paid after
each stage is completed, not before -- although some lenders recently have
loosened up on this standard, said mortgage expert Razmik Vartanian of Mark
1 Mortgage, by disbursing just enough money to cover deposits on supplies.
Construction
loans also differ from mortgages in how lending companies determine how much
you can borrow. Conventional
mortgage lenders base their loan maximums on the current value of the
property and loan 80% to 90% of that value.
Construction lenders, by contrast, may use the estimated future value
of your property -- what the home will be worth after it’s completed -- or
may base the loan on how much the project is expected to cost.
Containing
your costs
Say
you found a lot for $100,000 and plan to spend $200,000 designing and
building your castle. The
lender might require $5,000 in loan fees, plus interest and contingency
reserves of about $20,000. The total loan would be for $260,000 -- 80% of
$325,000.
Don’t
expect to cut costs by acting as your own contractor unless you’ve had
significant experience in construction.
Most lenders insist that borrowers hire a professional contractor.
“I have done a few construction loans for borrowers that had
experience building and acted as their own contractor,” said Bond of Palos
Verdes Funding in California. “The lender needs to have the confidence that they have
the experience to handle the job.”
“It
sounds funny, since this is your dream home, but you really do have to rein
in your desires,” Christensen said. “You
need a little self-censorship.”
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