Traditional Construction Home Loans
vs. Creative Financing
So you have the small home of your dreams in your mind, but it does not yet exist. Some people are lucky and can find their dream homes ready to go, complete with everything they need to move in and live happily ever after… and in the right location. Other people choose to look into building their own custom home and securing a construction finance home loan to get funding for their dream home. If this sounds like you, don’t fret. Many people have gone through the process of being the owner-builder and trying to secure financing.
Getting a new construction loan sounds like a hassle enough (and it is to some degree), but in the end it is all worth it. Nothing beats having a home built just for you, complete with everything that you ever wanted in a home. It may be a bit more work (that’s an understatement) and a longer wait than an existing home would be, but who wants to live in somebody else’s home when they can get the financing to have a house built to their very own specifications?
In my mind the final reasons for buying an existing home are these:
- acquiring the financing is a lot less stressful,
- you don’t have the headache of managing a building project,
- location, location, location.
If the area you want to move to (for work, school, or financial reasons) is entirely built up with houses you’ll have little or no choice in finding a new spot to build on.
Maybe putting off building your small dream house or cottage is in the cards for you. This may turn out to be a good thing, giving you more months and years to study plans, ask questions, help out on a Habitat for Humanity project, or visit the Midwest Renewable Energy Fair.
Of course, as it is with any type of financial transaction it is important to make sure that all of your ducks are in a row before even thinking about breaking ground on the new home. While nothing beats having a brand new home of your own, the process for securing construction finance for a new home is certainly more complicated than it would be to secure financing for an existing home. Your lending institution may just require you to have a general contractor (GC) head up the building project for their own financial reasons. Having the knowledge, licensure, and insurance of a GC tells the bank that the project is being overseen by an experienced builder (they tend to feel better about that).
I’m sure there have been banks that have gotten burned in the past when lending money to an inexperienced owner-builder. A project gets started, the foundation poured, walls start to go up, then some calamity happens. Maybe a disagreement between the spouses (or pending divorce), an injury that prevents the owner-builder from continuing on the project, or troubles with children or elderly parents. A thousand different varieties of “monkey wrench” can get tossed into a house building project. Having a contracted GC behind the project ensures the bank their money is being put into a finished and salable house.
Add to this the consideration that it usually costs substantially more money to build a custom home than it is to just buy an existing one. There are things to consider outside of the actual financial transaction to worry about in addition to those things that are included with the construction loan itself, like pricier architectural detailing or high-end finish materials. Needless to say, a construction finance home loan and the building process is not for the weak willed or high strung. It really requires the steady and persistent — and flexible — approach in the end.
If you are interested in securing construction finance, home loan officers at your local bank or credit union should be able to help you or at least point you in the right direction. These people know your financial history a great deal better than any outside lender. Seeking a home loan through an internet-based company is asking for trouble! And depending on how long you have been banking with them you may be pleasantly surprised at the interest rates they are able to offer you. A small percentage can equal a large amount of money when it comes to those percentage points, so keep that in mind when shopping for loans–especially if you are on a budget. Avoiding an “adjustable rate mortgage” (ARM) is highly recommended, too.
Keep in mind that when you have financed your home through a construction loan, your home is in the same danger as it would be otherwise if you fail to make good on your loan. Of course it is important to make timely and full payments on a construction loan, as the bank still has the authority to repossess the home if the payments on the loan are not made.
As you can probably tell by now, a construction finance home loan is sometimes very necessary in order for hard working people to get just the home they need for their families. There are some differences though, and the process itself takes a bit longer than it would otherwise and the loan works a bit differently. Either way, with due diligence, timely payments, and the right attitude through a very stressful process a construction finance loan can quickly make you the owner of your very own dream home.
Other Creative Financing for Home Building
You’ll probably agree that 99+% of new home construction is financed with a loan from a bank or credit union. I don’t have statistics on this, but this really can’t be too far from the truth. It’s the American way: borrow money to build, then spend the next 20 to 30 years paying it off. And I’m not even going to get into the slick and sleazy home loan practices of shady “lending institutions” of the past several years. I would venture to guess that these people had absolutely no foresight (or care) into what massive home loan defaulting would do to not just the housing industry, but the American economy, too. Creative financing for home building requires your to get, well, creative. So, let’s look at some other alternatives to going to a bank or credit union for money to build your house.
“Mortgage Free! Radical Strategies for Home Ownership”
by Rob Roy. Most of Mr. Roy’s strategies involve examples of how people started off in very small and/or temporary homes. Then over time added on or built a larger house that could be paid for over the course of several years.
This is the “old fashioned” way of building equity in a home over time. Hey, it’s how my grandparents did it, and I’m sure many others, too.
The best book on this subject I’ve read so far is Rob Roy’s Mortgage-Free!: Radical Strategies for Home Ownership (Real Goods Solar Living Book). He details many real life examples of people that have foregone the traditional borrowing route to finance their home building.
The most common way is to pay as you go. Save enough to buy your piece of land. Then work a few more years to save enough to build the core of a small house, say 20′ x 20′. Move into your tiny house and therefore save more money over renting. Work for a few more years to save for an addition like a larger living room or additional bedroom. Ad infinitum. You get the picture.
Using credit cards can also be factored into financing for home building, but I’d strongly advise against it. Credit cards are way too easy to overspend on. And their interest rate is generally atrocious (15-30% or worse depending on your payment history). The only upside to using credit cards for home building is that the money is “unsecured”, which means there’s no bank lender breathing down your neck making sure the house is on-time, on-budget, and built to a market standard (will it sell easily if put on the market tomorrow?).
If you’re using alternative building materials that a bank would naysay (strawbale, cob, cordwood, earth ship, etc.) then using your credit card might be the best bet to get some critical building materials to complete a stage of construction — like getting the roofing material on. Even if you’ve started your project with money from savings or investments, you may hit a point where you’ve temporarily run out but still need just a few more pieces to get the structure enclosed for the winter. Generally I would reach for the credit card, even a low rate money-back 10% off kind of card, as a last resort. Handing that plastic over to the cashier can be a slippery slope of unintended spending. Been there.
Borrowing money from family isn’t a good idea, either. Lending money between family members can start off with the best of intentions, but as the project drags on and on, and repayment becomes late or questionable, those good intentions can turn sour. Let your family contribute to your home building by actually offering some sweat equity, if able.
My own Dad put in many hours hooking up the wiring in my house (thanks, Dad!). Even Mom can help by making meals or sandwiches for the workers (thanks, Mom!!). Don’t want to be sexist here, but home building does require quite a bit of strength and stamina, something women aren’t ergonomically designed for. Although strategic use of ladders, clamps, pulleys, and ropes can often compensate for the difference (work smarter, not harder, as my Dad says).
The final form of financing I’ll bring up is the one I used for my house, and is probably the least common. Taking out a home equity line of credit on your current paid-for house. Securing this kind of loan doesn’t come with the stipulations that a construction loan would have (eg: having to hire a GC).
At the time we (I was married at the time) applied for a home equity line of credit (LOC) on our house in Appleton we were intending to use the money for home improvements. In actuality a LOC can be used for anything… improving the house, buying furniture, funding an education, buying a car, etc. We never got around to doing anything serious with improving the house when I happened across the best piece of land out in the countryside: a one acre parcel NOT in a subdivision and right across from a State Park.
There wasn’t a “for sale” sign, but that didn’t deter me. It took a year of gently conversing with and persuading the owners to sell their little piece. (Frankly, if I hadn’t run across that land and been able to buy it I would probably still be in my very trying marriage… but, that’s another story.)
My then-husband was aware of my pining for a country place since before I met him, and he agreed to using the LOC to buy the land and fund building a little house there. He, too, saw the writing on the wall about our lack to resolve a key issue in our marriage that would lead to our dissolution. The positive side of him was all for getting me into my little dream house out in the country.
So the LOC, that was originally acquired under the assumption that we’d use it for our house in town, turned into a de facto construction loan. When the pro-se divorce was final (at about 80% completion of the house) we agree to officially split the outstanding loan right down the middle. And since the house was nearly completed the credit union was fine with rewriting the LOC into 2 separate loans.
Having done our “banking” at this credit union for over a decade also helped. I knew some of the people, and had asked various questions of one particular loan officer over the years. Having the staff know a bit about you as a customer seems to help get a loan approved.
If you have other ideas about how to creatively finance your home building project that doesn’t require a construction loan, please let me know. Sharing your ideas will help others coming down the road after us. Sharing information is what the internet is all about.
How Home Construction Loads Work at Bankrate.com.
6 Must Do’s for Homebuyers applies more to acquiring money for purchasing an existing house, but still some good advice you can glean here.
Creative New Ways to Finance a Home offers 10 more ways to buy a home, including some government programs.