20
Dec

Construction Lending Basics: Financing your Custom Home

Guest Post : Stephen Puckett – Mortgage Loan Officer – Legacy Texas Bank

Being a homeowner can be both rewarding and frustrating – a feeling of satisfaction closing on that very first house then, over time realizing a room or two could be bigger, the kitchen no longer supports a changing lifestyle, an extra bath, another garage bay, outdoor kitchen/pool… You develop aspirations to build and live in a true custom home based on personal vision and design, utilizing ideas and concepts accumulated and tested over time – location, style, floorplan, materials, amenities….

Unless you have sufficient cash to finance this major expense all out of pocket (congratulations, if so) you will need a lender that offers construction financing for both land and improvements with terms that best fit your project needs. You may be familiar with mortgages, but this loan type differs as is in two parts: it must cover the lot and construction of the home (the short term ‘interim’ portion, usually 6-18 months) then, you must have firm plans in place for approved permanent financing( the long term ‘Perm’ loan) to replace the interim upon completion. Your equity goes in up front, requirements vary based on cost, credit… usually 10-20% (lot equity may count if currently owned). In addition to standard loan qualifying and requirements the lender will require a construction contract and information on your builder plus the plans/specs and proposed budget/draw schedule to support the project. Work may not begin until the loan has closed, and then as each phase is complete the lender will pay builder in stages upon inspection, you then pay interest monthly on the current total.

Having located a suitable area and lot on which to build, you seek out a qualified builder based on defined criteria and personal needs: style, quality of work, reputation, availability, affordability… Does the builder offer a fixed price or do they build on a ‘cost-plus’ basis? Many builders today offer design/build services based on their own style, translating to expedited planning and budgeting, leading to an agreement on a contract and the other big step: financing approval and closing.

The two basic loan types to finance a custom built home (vs. self-financed volume builder):

  1. Two Time Close – This traditional approach entails the closing of two separate loans – the interim up front and then a perm at the end, with 2 closings and 2 full sets of standard closing costs. This interim financing type requires that a pre-approved perm be in place that you will re-qualify and close again upon completion (again, w/closing costs). Take note that you typically do not lock the final perm rate until 60-90 days prior to completion which, in an unstable or rising rate environment may expose you to rate risk and those additional costs.
  2. One Time Close (a.k.a., Single Close) – Many homebuyers choose the convenience and savings of having the interim combined with the perm in a single transaction, with reduced costs and seamless rate protection, called a construction-to-perm, or, One Time Close loan. This loan type eliminates the need to refinance (close again) after construction, with a single set of closing costs (up front), eliminating the expensive, uncertain second round. This affords the same 6-18 month short-term construction period (interest paid on draws), and then modifies to the perm with a pre-determined rate upon completion without re-qualifying and little if any signing or expense. The guaranteed locked rate up front for the both the interim and the perm phase, alleviates long term interest rate risk and worry during construction, and provides peace of mind in an unstable or rising rate environment.

We are fortunate to have many lenders from which to choose in our area and, a select group within the ranks of the 75 year old Dallas Builders Association. Understand that that not every Bank supports this loan type, so be specific when asking about programs, rates and terms, which will vary. Do your own research well in advance for both the builder and lender choice. By prequalifying and then, with a clear understanding of the loan process and your options you are better positioned to discuss and negotiate project terms with a builder freeing you to focus squarely on the project, unencumbered by uncertainty.