Finance Roll

Sometimes it's a rude awakening. Imagine adding 5-10% to the cost of your home building project ... just for the cost of financing! Well, that's often the case. Money doesn't come cheap. Even when interest rates are relatively low.

Most of us have experienced the process of procuring a mortgage when either buying or refinancing a home. We know about interest rates, closing costs, and appraisals. When you are preparing to build a home things get a bit more involved.

Construction Loans: Your Bank Loves You, But ...

So often I hear people say they aren't concerned about the loan to build their home. They have a good relationship with their bank and they "know" that it's not an issue. Whoa, hang on a second. It pays to contact them early in your planning and get some specifics. Here are some of those specifics:

• Are you an owner builder or are you turning it over to a licensed contractor?
• Does your bank screen the contractors for approval?
• What kind of equity does the bank require you to have first?
• Do they use a "builder's control" system for paying bills?
• Will you be required to make construction loan payments?
• How many months is the construction loan term?
• Will the loan automatically roll over into a 30 year mortgage?

These are important questions to ask. You don't just want to ask if they do construction loans and leave it at that. It could seriously undermine your planning and preparations.

The Cost of Your Construction Loan is Another Story Entirely

Now that you have your answers and you are satisfied that you can get what you need, what's it going to cost you? Prepare to be impressed. And, not so much in a good way. Interest rates are only a part of the story.

The lender wants you to budget your project. But, you have to also budget in the cost of the lender! Let's take a look at why that can be a big chunk of change.

1) Points: Sometimes this can be confusing. What are points and why are they charged? You could look at points as a tax or a fee added on to the loan. It's really a way for the lender to charge for their services while still appearing to be competitive with their rates.

A single point is one percent of the amount of the loan. With construction loans, points are sometimes higher due to the added risk the lender is taking. To give you an idea, if a regular mortgage would require one point, a construction loan could be two or three.

2) Appraisals: Whenever you get a loan on real estate, it is a given that the lending institution will want to establish the value by ordering an appraisal. When you're applying for a construction loan there could be more than one appraisal required ... often there are several. At a minimum, they'll want the current land value, the current projected value of the home to be built and perhaps the value of the home once completed.

3) Administration fees: Putting together and managing a construction loan is more time consuming and costly than the regular mortgage that you might be accustomed to. This is something to discuss with your banking institution or mortgage broker.

4) Interest Reserve: There will be interest charges. Whether or not you have to make payments along the term of the loan, you'll need to incorporate these charges into the loan amount itself. So, if you do not make the payments along the way, you'll be including an interest reserve which simply adds to the amount you need to borrow. (On average, this could add $15-25,000 for a project)

5) Contingency Reserve: Oops! Another reserve? Quite often, yes. Many banks and lenders will require you to set aside an additional amount within the loan amount to cover the "what-ifs" of building. And most home building projects will have some of these. I believe it is wise to include them whether or not your lender requires it. (Many times it's wise or required to add $20-30,000 or 5-10% of the total cost of your project.)

What Does All This Mean?

Even if you don't end up using the contingency reserve fund, you still will have to figure it in to your planning and qualify for that additional amount in your loan. This could reduce the amount of funds available for building your home.

Certainly it's no fun thinking about the cost of borrowing money. Yet, it's the system we have and frankly, without it, how would we go about something as magnificent as building a home? The bottom line is that the system gives us an opportunity to create that dream home and make it happen now.

Learn all you can first. Prepare yourself well. Get a good coach to help you convert your ideas into practical steps and then get to stepping!