How to Pay for Your Custom Home, Addition, or Remodeling Project
Have you ever wondered how to pay for a custom home, addition, or remodeling project?
Find out from our Fairfield County based architect, DeMotte Architects.
There are a few ways to pay for or finance your project, and your options will vary depending on the type of project you’re doing. If it’s a custom home, you’ll have certain options available that don’t apply to other types of projects such as additions or remodels.
In any scenario, the first thing to do is to do your homework & get ready:
- Review your credit information & make sure it’s accurate.
- Provide documentation of income, employment, 1-2 years of IRS filings, bank accounts, 401k’s & other assets.
- Summarize your monthly household expenses.
This criteria will be used to determine the amount of money you can borrow & the price of the house you can afford.
Ways to pay for home projects:
The easiest option (if possible) is to pay with cash, whether it comes from savings or private loans from family members or trusts. That said, I find that many homeowners able to pay in cash prefer to borrow money if finance rates are low, as their money is more wisely used to generate more money by investing.
This is a very common option when combined with cash, which is done through banks.
Unlike long-term mortgages, construction loans are short-term loans with a payback period between 12-18 months, which is usually enough time to complete construction. This loan is then converted into a long term loan (mortgage) ranging from 15-30 years.
These loans are typically interest-only, with variable rates tied to the prime rate. Don’t expect the bank to underwrite the entire project, as lenders will want you to have some skin in the game. You can expect to pay a portion of the costs (somewhere between 10-20%) to share in the risk of the project.
If you already own your lot, the equity in the property can be included as part of the collateral for the construction loan. If you bought the land with a lot loan, then the construction loan would be used to pay off and refinance that first loan. If you’re buying a lot with the construction loan, you’ll coordinate the closing for the purchase of the lot with the construction loan closing.
The bank will typically want to see preliminary plans when you first start discussing the project with them; then they’ll require a final set of construction drawings. An appraisal will be done based on the drawings & the bank will give you a loan based on the future value of the home. During construction, you’ll draw money based on invoices from the contractor, with the bank sending their own inspector to verify the work in progress before they release the funds.
Note that the initial bank appraisals are typically conservative, as most houses will usually appraise much higher once completed. You may need to set aside enough cash at the end of the project to make up the difference if needed.
Home Equity Line of Credit (HELOC):
This is a loan on the equity in your house, which is a great option when adding onto or remodeling a house you’ve lived in for some time & have built up equity over time.
You’re essentially borrowing money from the bank against the value of your house & paying off the loan over time. This type of loan clearly isn’t an option if you bought a house as a tear-down, as you’d no longer have an equity in the house; you would only have equity in the value of the land.
If part of the house is being saved though, a creative bank might let you start the project with a HELOC & then convert it to a construction loan during construction.
This is a short term (6-9 month) loan designed to cover the gap when you’re buying a new house but haven’t sold your existing house yet, so you don’t have all the cash you need. You could also use the money to remodel your current house.
Note that these loans have higher rates than a regular mortgage & things can get messy if the house doesn’t sell before the time limit expires.
While clearly not a conventional option, it is possible if you have high limits available to you. While you may not be able to finance the whole project this way, things like appliances, plumbing fixtures & light fixtures can surely be bought on credit & paid off over time… just be mindful of the interest rates.
Loans specifically for custom homes:
If your credit history is very good & you’ve got a minimal amount of money for a down payment, a federal government-backed loan may be your best choice. Down payments can be as low as 3.5%, with generous credit underwriting.
These loans have the advantage of no down payment, but you must be a veteran to qualify.
This type of loan may be your best bet if you have more than 10-20% for a down payment. These loans are designed to be sold to Fannie Mae & Freddie Mac, which are the government-chartered mega-investors.
Down payments below 10% may be allowed but will require a high private mortgage insurance premium. Conventional underwriting rules are stricter than FHA or VA loans, & banks may add their own fees, which increase your cost.
Construction loans: (see previous)
This type of loan doesn’t apply to most custom homes built by your typical contractor, but might apply to a large scale builder who’s developing a subdivision & is working closely with banks, mortgage companies, or their own in-house subsidiaries.
While there may be significant value in builder-financed packages, sometimes they’re not the most favorable when it comes to interest rates, fees, & the range of loan types. It’s always best to shop around.
The best way for you to finance your project will depend on many factors. Do your homework, shop around & find the best one that works for you.
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