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Building Your Dream Home, Pt. 1

October 5th, 2006 · No Comments · Construction Loans

For many Americans, there is a deep-rooted desire to build their own home.  In the busy suburbs of Silicon Valley, empty plots of land are few and far between these days.  As a result, the remodel project has become a booming industry over the last decade.

The first and largest hurdle in planning your dream construction is to determine how much it will cost you.  Most architects around the San Franciso Bay Area will tell you that the cost of construction is going to be $300 to $400 per square foot for a new custom home using good materials.  By good, they mean oak hardwood floors, granite countertops, marble in the bathrooms, and some mainstream brand appliances like GE and Maytag.  They do not mean fancy pecan flooring and a Subzero fridge, Miele washer and Thermidor stove.

So if you were to build a 2500 sq. ft home, that cost could run between $750,000 and $1M in construction.  This does not include whatever you spend with the architect and designers. 

If you own your home and are building on another empty lot that you own, you may be able to pull some equity out of your home at a favorable interest rate.  However, you will likely end up needing to obtain construction financing for all or some of the project.

Construction loans are much higher than regular mortgage rates.  Why?  Because the bank is essentially lending on the dirt value in the event that the construction is not completed.  This means it is a much higher risk loan so the banks will charge much more.  Additionally, the term of a construction loan is shorter, as it won’t take you thirty years to build a new house. The higher interest rate is a way for the bank to get a greater yield during the life of the loan. 

A conventional lending institution may not approve your construction loan application if the risk exceeds their underwriting guidelines.  The remaining option is then working with a private money lender.  Private money is usually faster, but charges far higher interest rates as they will underwrite a higher risk loan.

Things that a lender will look for:

1) Are you the owner-builder? What experience do you have in construction?

2) If you are hiring a general contractor, what experience does he or she have in completing custom homes?  References? 

3) Do you have an established timeline with all the construction milestones?

Most lenders will employ a service like Builder’s Control, to monitor the percentage of completion before disbursing the funds for the next milestone.  That’s right, the loan fund are generally disbursed piecemeal as construction borrowers are a bit of a flight risk. 

If you are re-building your home after a fire with insurance proceeds, the same is generally true of the insurance proceeds.  The insurance company generally will not disburse the entire amount all at once to the insured. 

If you plan to build your dream home, prepare your budget and set your expectations accordingly.  The construction of a custom home requires the input of many professionals to ensure that the construction is funded and completed. 

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