Most new homes in America are built by builders or developers who build the new home with their own money or lines of credit in order to sell the finished home to the new customer. The new buyer simply obtains a regular "purchase money" loan and buys the house.
This is the simplest form of construction financing. Of course, the builder's borrowing costs are built into the price the new home buyer pays.
Increasingly, however, this form of financing is becoming rarer. Often, builders are becoming more reluctant to use their own funds to build for someone else as their banks are tightening their lines of credit and making it more difficult and expensive for them to get the needed funds.
As builders become less likely to fund your new construction, prospective new home owners who wish to build a custom home are forced to fend for themselves when it comes to construction financing.
Enter the construction to permanent (CTP) loan.
There are a wide variety of construction loan choices out there. And many of them are woefully inadequate for most people - especially if you want to act as your own general contractor (known as owner-builder construction).
Local banks tend to be very conservative and will not even consider lending their money unless you fit exactly into their guidelines. This typically means having a fixed price contract with a licensed and approved builder, selling your current home prior to qualifying, and even making a large down payment or owning the land first.
Occasionally, a local bank will give you permission to be your own contractor, if you jump through enough hoops for them. They may require an extra large down payment or that you own the land free and clear before they lend you the money to build. In the end, most local bank's construction loan programs will have one or more restrictions that make their programs unusable, more restrictive and even more expensive than a good alternative.
As an owner-builder, your search for a construction loan should be focused on finding the loan features that will best fit your scenario. Finding this type of program gives you the greatest chance of success and your best opportunity to save money on your project.
Within the world of owner-builder construction loans, there are only a handful of options that make sense. Some of the features that should be most important are:
o Ability to be your own contractor without needing to make a large down payment - if any at all. "Large" means anything more than 5% for a conventional size loan and 10% for a loan up to $1,000,000.
o No "consulting fees" or monthly "administrative" fees charged to you just for doing a loan. Please understand, you need to expect to pay for an owner-builder loan in the form of origination or discount fees, but you should not also need to pay a consulting fee.
o No requirement to sell your current home before you can qualify for the new construction loan. Many lenders will force you to sell your current home before you start building the new one, meaning you will be forced to move twice in a short time just to get the loan.
o No payments, interest or other, while you build. The best CTP loans allow for an "interest reserve" to be built right into your new loan so you are not forced to make both your current home's payment plus the new one. Most programs that allow for an interest reserve also allow you to choose to make the monthly interest payment if you want.
o No upfront or "application" fees. Avoid any lender who requires any kind of upfront fee or "deposit" of any kind.
o Easy draw administration and unlimited draws. This means easy for you, the owner-builder, not the bank or your sub-contractors. After all, if you can't get access to and control your money, all the other terms really don't matter.
o One-Time closing. The best construction loans allow you to close only once for both your construction funds and your permanent mortgage. This will save you several thousand dollars in the long run.
o A staff of professionals who understand both construction and construction financing. Ask the person you are speaking with how many homes they have built themselves as an owner-builder. If you are dealing with a loan officer who has never built his or her own home and cannot speak to you from specific experience, you should look elsewhere.
The importance of working with knowledgeable professionals cannot be stressed enough. Half of the battle is learning to ask the right questions.
Note that the above list did not mention anything about construction interest rates. It is not that rates are not important; it is just that they are among the least important features of a good owner-builder construction loan.
This does not mean that owner-builder loan interest rates are necessarily higher than other construction loan rates - they will probably be about the same. But, who cares? It really shouldn't matter to you if the interest rate during the period of construction is the same, a little lower, or even a little higher than a construction loan in which you are required to hire a builder.
Why? There are a couple of reasons, actually.
First and foremost, you are seeking a loan that will enable you to save tens of thousands of dollars by acting as your own contractor. The tiny (and it is tiny) difference in interest you will pay over a six to twelve month period is meaningless when compared to what you will save by being your own GC.
Second - and this is important to remember - despite the fact that every potential owner-builder is positive that he or she will build successfully on time and under budget, the reality is that owner-builder loans represent the most risky category of construction loan a lender can make. That is why there are so few available to start with. And, that is why you need to be prepared to pay a little more for the privilege of getting one of these loans.
Smart owner-builders understand that they need to focus on that "big picture." Your goal is to build the exact home you want, your way, while saving tens of thousands of dollars. If the vehicle you need to reach that goal costs a little more, why should it matter? It is important to remember that:
A) Construction loans are short-term loans and the rates are therefore tied to short term funds - typically the prime rate. As the prime rate goes up, construction rates* will follow. And, vice-versa.
B) Owner-builder construction loans are very risky and very specialized. Accept this fact and the fact that you may pay a little more for the privilege of having access to this type of money.
C) Your permanent rate, and the choices you have related to that, is the more important thing to consider when looking at rates.
D) Rates are the least important feature to shop for. Remember to focus on the features that will benefit you the most and help you accomplish your goal - the big picture!
The smart shopper shops for loan features, not interest rates. The features that an owner builder needs are not necessarily the same as those a borrower hiring a general contractor needs. Refer back to the list of important features above as you examine loan programs. And always remember that you are in charge during this process.
