Many people investing in vacation properties decide to build a new home rather than purchase an existing home. Choices they make may range from using an architect to design a dream home to simply finding existing plans and choosing a builder. In all cases, the first decision is choosing the land or lot itself.
Once the location, plans, builder, and construction cost have been determined, the next question to answer is how to finance the construction. These choices range from cash to mortgage financing. In determining the best method of mortgage financing, a number of factors need to be taken into account.
Many banks offer construction loans, where the loan is set up so the builder can draw funds during the construction phase. These loans have costs associated with them, typically construction loan fees, inspections, processing, underwriting, appraisal, title, recording, and escrow closing fees. Interest during the construction phase is based on the drawn amount and either billed to the customer or taken from a prepaid reserve account.
When construction is complete, the construction loan needs to be paid off. This is typically accomplished with a traditional mortgage loan, or permanent loan. Once again, the customer incurs the loan fees and all other fees normal to any mortgage loan. The negative aspects of this type of construction-permanent financing are obvious: two closings double the closing costs, and interest rates may change during the course of construction.
The mortgage lenders providing the best financing for building offer one-close construction loans. These loans also allow the builder to make construction loan draws during construction, then automatically convert to the permanent loan on completion of construction. Besides the obvious cost savings of only one closing, the other primary benefit involves the interest rate on the long term loan: in many cases, the lender will lock in the rate at the time of the first closing. This means that the customer knows what their payment will be when complete, regardless of market fluctuations during that time.
There are other benefits created by one-close loans depending on the length of time the property is owned. Since many people purchase the land and build at a later time, their equity or appreciation during that time can work to their advantage, as the loan to value determination is based on appraised value, rather than cost.
For example: a customer purchased a lot for $200,000 that has doubled in value over time. They now wish to build a home with construction cost of $600,000. The appraisal comes in at $1,000,000. Since the lender will finance up to 80% of appraised value, there is $800,000 available. This will finance the construction, pay off any land loan, and include closing costs and construction interest in the loan, providing a true turn-key project with no out of pocket costs and payments starting when the home is complete!
Home builders also prefer this type of financing, because their own financial resources and credit lines are not needed. Since the customer is financing construction, the builder does not need to build in financing costs that would normally occur if they were building the same house for speculative sale.
Realtors who work directly with builders are also finding the benefits of one-close financing: Instead of just selling the land, and earning commission on the land portion, realtors can be instrumental in linking up the customer and the builder, selling the land and construction package and earning commission on the entire value.
The best advice for anyone deciding to finance the construction of a new home is to seek expertise in mortgage financing for their particular need. Companies advertising "we do everything" may not have the necessary lending relationships, just as banks offering two-step construction to permanent may not be competitive. In all cases, the customer will find that one-close construction loans save dollars and make sense.
James J. Johnson has over 30 years experience in financing purchase and construction of resort and high-end properties. As Director of Idaho Property Funding for Mountain Mortgage Centers, he can be reached at jj@resort-funding.com or 208-634-9770
website is http://www.resort-funding.com
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