Building Your Custom Home Series, Part V: Financing

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Money.  This isn’t everyone’s favorite topic but when it comes to building a custom home, it is one of the most important conversations you will have.

Shortly after the housing market went into recession, a financial crisis swept in and really changed how banks (and the government) look at construction lending.  There were sweeping changes that caused some banks in some markets to put a moratorium on all construction loans.  That never happened here in Northern Virginia but it did becoming increasingly difficult to get a construction loan.

While the requirements haven’t eased, the lending programs have gotten a lot better and banks seem to have a greater appetite for construction lending.  This is great for borrowers because they have the opportunity to hold onto more of their cash with some banks offering a 10% down payment program.  This has been unheard of in the last 5-6 years.

I’m not a banker so I’ve asked one our lenders to write about financing your custom home project.

I’d like you to meet Mike Zell.  Mike lends money and he’s really good at it.

FINANCING YOUR CUSTOM HOME PROJECT

NDI Clients fall into one of two categories when it comes to financing their build:

1)     Clients building an NDI home on their existing lot

2)     Clients purchasing a lot to build their NDI home

Building on an Existing Lot

For NDI Clients building on their existing lot, the construction loan amount will be the balance of the existing mortgage (if one exists) and the cost of construction.  At closing the existing mortgage will be paid off and that will be the first “draw”.  At that time you will start paying the interest only payment on the payoff amount.

Please note, if you have an existing mortgage, you cannot keep that mortgage and build a new home even if you have the cash to pay for the new house.  The terms of a conventional mortgage prohibits you from altering the collateral (the house) in any way that reduces the value.  Tearing the house down will absolutely reduce the property value until the new house is up.

To determine equity and the down payment for the loan, the bank will consider the appraised value of the new home based on plans and specifications.

For example:

Current Mortgage = $330,000

Cost to Construct= $400,000

Site Work Costs= $70,000

TOTAL LOAN:   $800,000

Appraised value of new home: $1,000,000

Required Equity in transaction: $200,000 (20%)

Equity in transaction: $200,000

Down Payment: $0 (there are closing cost and reserve requirements not part of down payment)

Closing costs vary but the lender must provide you with the total amount of closing costs prior to closing.

Building on a Lot Purchase

For NDI Clients purchasing a lot to build their NDI home, they will need financing to cover the purchase of the new lot and the cost of construction.  At closing, the lot purchase amount will be the first “draw”.  At that time you will start paying the interest only payment on the lot purchase amount.

This type of loan is called an Acquisition Construction Loan. To determine equity and the down payment for the loan, the bank will consider the following:  cost of the lot or appraised value of the lot, whichever is less, cost to construct plus allowable site work.

For example:

Lot Acquisition = $550,000

Cost to Construct= $400,000

Site Work Costs= $75,000

TOTAL ACQUISITION:   $1,025,000

Required Down Payment: $205,000 (20%)

There are closing cost and reserve requirements not part of down payment.  Closing costs vary but the lender must provide you with the total amount of closing costs prior to closing.

How do the payments work during construction?

If you have an existing mortgage or lot purchase, you will have been paying the interest on that amount since the loan closed.  Once construction starts, NDI receives payments on a draw schedule based on five critical phases.

Foundation walls complete………………………………….$____(20%)

Under black paper, windows& doors installed…………. $____(25%)

After mechanical & ready for drywall……………………$____(20%)

After 1st trim…………………………………………………..$____(20%)

Final………………………………………………………………$____(15%)

After each of these phases is complete, NDI will call the bank for the draw to be released.  The bank will send out a 3rd party inspector to verify the work is completed.  After a quick title search to verify no liens on the property exist, the draw is released.

Payments are interest only on funds disbursed at the time of billing, not on the full loan amount. You will also be responsible for all County and City Real Estate taxes during construction as there are no escrows during construction.  You will also need to purchase Builder’s Risk Insurance prior to closing on the construction loan.

Charter One Mortgage offers a onetime close, so at conversion to permanent you will begin paying Principal, Interest, Taxes and Insurance and set up escrow account for taxes and insurance.

For example:

First loan disbursement to pay off lot: $330,000

Rate: 4.25%

First Interest payment: $1,168.75

As the draws are paid out the balance will increase thus increasing the monthly payment.

Once construction is complete and the Certificate of Occupancy (also called Occupancy Permit) is issued, the final draw will be released.  After the final draw is released, NDI will hold a settlement with the client.  This settlement has nothing to do with the permanent loan financing but is the time they will receive the keys, home warranty information, paint touchup kit, etc.

The conversion to the permanent will occur after the client takes possession of the house.

Do you have questions about Construction Financing?  I’m happy to help.

CHARTER ONE BANK
Mike Zell
Branch Manager
1800 Diagonal Rd,  #600
Alexandria, VA 22304
703-946-0957
mike.zell@charteronebank.com

Mike Zell works for Charter One Mortgage and has been in the industry for over 30 years.  He lives in Stafford with his five dogs.  In Mike’s free time, he enjoys traveling, cooking and the outdoors.

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