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Home Building Loans
Funding Your Project

Unless you have enough cash available to cover construction costs, you will probably be faced with getting a Home Building Loan to fund the project and Permanent Financing which you will pay off over 15-30 years. We say "probably" because it is possible to avoid construction financing if you build fast enough.

There was a builder in Oregon who developed a system of construction that allowed him to build homes from start to finish in less than two weeks (Builder, November 1, 1981, p.42).

The homes were all "pre-sales" . . . that is, he had a contract on each home before construction began. He was ready to "close" on the home (complete the sale and get his money from the buyer) before most of the construction costs even came due!

Most of us, however, will not be able to duplicate that feat, and will thus be faced with securing the necessary construction financing.

The first step is to get qualified for your permanent financing. First you'll want to determine how much home you can afford to build - or maybe just how much you want to build. How much you can afford depends on your disposable income. In other words, how big a house payment you can afford to make.

Of course that's a gross simplification! There are other considerations - like, for instance, how much cash (down payment) you have to put into the project and how good your credit is.

You can meet with your lender (which you'll have to do eventually!) or you can get a pretty good idea online. There are hundreds of sites. Here's a couple.


Your credit rating

Prequalifying for a loan

In case you're wondering how this all works, lenders use certain (qualifying) formulas to tell how much you can afford. All this is explained in our section on developing your budget.

Every lender will have slightly different rules for home building loans, some of which may be more stringent for Owner Builders.

Bottom line - The lender wants to cover his behind. If you're going to be an Owner Builder, he'll not only want to know that you can repay the loan, but equally (or even more) importantly - that you can successfully carry it off (the Builder part), before committing to a home building loan.

Once you're qualified for the permanent financing, you can get to the particulars of the construction loan. Click here to find out more, including sources of home construction loans, what you should know about appraisers and appraisals, the cost of the loan, about 100% financing, and more.

So where do you start looking for the money? Many of you will already have banking connections. Perhaps you already have a home loan. Maybe you've even had a home built for you.

If so, you know where to start. If this is your first time, not to worry. Remember, one out of every ten homes built in this country are owner built! So there are a lot of lenders out there looking for your business.

Sources of Funds

Here are some places you may explore in getting your home building loan in place.


 
Commercial Lenders
There are many sources you may consider in seeking your home building loan. The most common source is a commercial bank, a credit union, or a pension fund.

VA
If you are a veteran, you may want to look at getting a VA construction loan. The terms are usually very attractive. For details, call your local VA office or click here.

FHA

If your prospective home fits certain guidelines, it may qualify for an FHA guaranteed loan.   These loans are available through approved participating lending institutions and are regulated by the Federal Housing Authority - a part of the Department of Housing and Urban Development (HUD). The FHA guarantee makes the lender feel a lot safer.

An FHA guaranteed loan might carry a lower down payment and a lower interest rate. However, there is a price to pay. The FHA loan has a ceiling (upper limit) on the price of the home.

Also, there may be a fee involved (called "points") that will improve the yield of the loan - thus making it more attractive to the institution that will eventually purchase it from your lender.

Finally, you will "pay" for a VA or FHA loan in the time and money it costs to have your home inspected during construction by a government inspector.

This site will get you started in finding out if you qualify for an FHA insured loan, and in finding an approved FHA lender. Although it primarily deals with home purchases, its information applies as well to new home construction as far as qualifying for the permanent loan.

FmHA Home Mortgage Loans
In rural areas, the Rural Economic and Community Development (formerly the Farmer's Home Administration, FmHA) offers direct mortgage loans to buyers who fall within some relatively strict guidelines.

This program is a straight government subsidy, with money allocated to local offices on a quarterly basis.

The office processes the mortgage application as soon as you apply, generally before you've found a house, and then notifies you when the money becomes available.

Depending on the area, some offices will have money available immediately, others will have a waiting list up to several months long.

Check them out here.

Private Sources
Of course there are also private sources of construction financing. You may have an easier time convincing a friend or relative that you are qualified to contract your own home than you would a banker.

You could pay a flat fee or an interest rate for the money. A good tactic is to offer more than they could earn on their money if it were simply sitting in a savings account or a certificate of deposit.

Once the home is completed, you should have no problem getting permanent financing (which is used to pay off the home building loan). This is because your own experience and abilities are no longer a factor.

The home itself guarantees the permanent loan. Incidentally, permanent financing really isn't permanent . . . it just runs so long (30 years) that it seems permanent!

The Secondary Market
Perhaps you have heard or read about "Fannie Mae" loans. This is not a source for you to obtain construction or permanent financing. This cute name stands for the Federal National Mortgage Association, which is a stockholder-owned institution, operating under a congressional charter.

It is engaged in the secondary   mortgage market. That is, it will purchase your loan (mortgage) from your local bank and sell it to an investor like an insurance company or a pension fund for a labor union.

Fannie Mae's "brother" organization is "Freddie Mack," the Federal Home Loan Mortgage Corporation. Because of poor management, the collapse of the housing bubble and subsequent $700 billion bail-out of the U.S. financial institutions in 2008, the federal government put Fannie Mae and Freddie Mac under the conservatorship of the Federal Housing Finance Agency (FHFA) in September of 2008.

The Permanent Loan

As I mentioned above, the place to start with your financing is to qualify for your permanent financing. This is familiar territory for most people. Explaining all the ends and outs of home loans is outside the scope of this site. There's already tons of information about home mortgages on the net.

And besides, we're not experts on this subject! We're here to help you build your own home. Irregardless (I've always wanted to use that word!) here are some of the old options. It's gotten a lot more complicated today. Here's a good site for more.

The "Standard" Loan
The typical permanent loan will be for 80-90% of the appraised value of the home, with a fixed mortgage payment for 15-30 years. An alternative is presented below. No lender will advance a construction loan until he has qualified you for a permanent loan as well.

Adjustable Rate Mortgage
If you end up getting separate construction and permanent financing, as opposed to a roll over loan (explained below) you may want to look at an Adjustable Rate Mortgage (ARM) - sometimes called a Variable Rate Mortgage (VRM). Your lender may even be able to tie one of these into a roll-over situation (see below). The ARM has several features that may make it attractive to you.

Points Required
First, most ARM's require you to pay some "points" (money!) up front that will lower your interest rate for the first two or three years. This has the effect of lowering your payments for that period, possibly allowing you to qualify for a larger loan. Of course, this assumes that you have the ready cash to pay the points.

Flexibility of the Rate
Second, the interest rate, over the life of the mortgage, is flexible within certain limits. It can be raised or lowered to bring it into a fixed relationship (margin) with one of the established economic barometers (index). The advantage of this is that if payments go up later, it is assumed that you'll probably be making more money then and can handle it. On the other hand, if the payments go down, so much the better!

Other Features Of The Adjustable Rate Mortgage
Some of the subjects and concepts you should know about, and some of the factors you should compare when shopping for an ARM are:

1. Fixed and ARM Annual Percentage Rate
 
2. Adjustment Period
 
3. Index Used and Current Rate
 
4. Margin
 
5. Initial Payment Without Discount
 
6. Initial Payment With Discount
 
7. How Long Will Discount Last?
 
8. Interest Rate Caps:   Periodic?   Overall?
 
9. Payment Caps
 
10. Negative Amortization
 
11. Convertibility or Prepayment Privilege
 
12. Initial Fees or Charges

Your mortgage broker can explain all of the above and how each affects your Adjustable Rate Mortgage. Here's more from a good site on the Internet.

A Combination Or Roll-Over Loan
If you are dealing with a commercial lending institution (bank, savings & loan, etc.) rather than a private source of funds, you should try to arrange for a roll-over loan.   Under this type of financing, your construction loan will simply become your permanent loan when construction is concluded. The terms may vary slightly under the permanent loan, but there will not be a separate closing (with its associated costs to you). Herein lies the big advantage of this type of financing.



Phew!
That's a lot of information for one page. We need to cover the construction loan - especially from the perspective of the owner builder. And there's a good bit to go over in this part of home building loans. So I think we'll break off here and get into the construction loan on its own page. Click here to go directly to Construction Loans.



For additional information on funding your project,
see Lesson Twelve of our online course
Successful Home Contracting
.

 


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