Buying a newly constructed house is a distinctly different experience from purchasing a previously owned home. There’s the sweet smell of sawdust, rather than the musty odors even the most fastidious homeowners can leave in their wake. Colors match your taste: No need to tear up someone else’s avocado carpeting. However, finding the money to pay for it all can be the equivalent of a short course in personal finance.
At the onset, the subject of financing new construction is complicated because there are three distinctly different categories of new home buyers: The custom-home buyer is building his personal dream home and selects every detail. Semi-custom buyers enjoy considerable decision-making, but they usually are limited to choosing a lot within a subdivision and selecting among several design plans.
Production or tract subdivision buyers have more limited choices, and typically pay a lower price for their home than either semi-custom or custom purchasers.
Eager to make a sale, a builder often helps a buyer find financing that works for him. In tract developments, especially, cash-squeezed first-time buyers may find a cooperative builder and lender can team up to provide an affordable financing package.
And just as fashions in flooring or countertops change, there are trends in financing. One of the most notable trends affects custom buyers. Lately, lenders are bundling the money used for construction and the final mortgage into one loan that requires just one formal closing.
Until a few years ago, anyone building a house on his own (meaning not in a subdivision) had to obtain two separate loans. First, he would get a short-term construction loan to pay the builder as he constructed the home. Then, once the home was complete he’d seek a long-term mortgage that would pay off the construction loan. Each loan required a separate “closing,” which involved costly charges for appraisals, credit checks and other legalities.
Now, most people constructing their dream house are obtaining a simpler and less expensive “construction-perm” loan, explains Ken Perlmutter, president of Perl Mortgage, a Chicago mortgage brokerage. “What we are doing is lending based on the after, completed value rather than what it (the site) is worth today.”
Often, lenders will require that the buyer already have purchased the lot before seeking a construction-perm loan, but it’s not strictly necessary, says Perlmutter. He provides this hypothetical example:
“Say a lot costs $70,000 to purchase, and it costs $200,000 to construct a house on it, and that after you’re done, the total value will be $300,000. (The value of the lot escalates once the completed new home rests on it.) It’s routine to ask for at least 90 percent financing, meaning that the borrower has to put in a 10 percent down payment, or $30,000. We would then hand over $70,000 at closing to pay for the lot, and the remaining $200,000 would be disbursed during the construction process as work is completed.
“We typically have four draws where the builder is paid, and before we pay, an appraiser goes to the site to make sure the work has been completed. At the end, the buyer gets a new mortgage for the $270,000.”
The new $270,000 mortgage can be in whatever form the borrower selects. He can choose an adjustable-rate loan, for example, where the interest rate fluctuates each year, or a fixed-rate loan, where interest remains constant.
Before a lender will grant a construction-perm loan, the borrower has to present detailed plans and specifications on the proposed home, so that the lender can have an appraiser visit the site and to ensure that the home to be built won’t be so quirky or so wildly expensive that it couldn’t later sell for what it’s costing to construct on the particular lot.
These steps, such as checking the site and the reputation of the builder, as well as making spot checks on the progress of construction, means that making a construction-perm loan is more labor-intensive than granting a garden variety mortgage loan. Consequently, lenders charge borrowers more. “The lender will probably charge a point or a point and a half,” says Brett Bowen, executive vice president of Chicagoland Mortgage Corp., a Park Ridge brokerage. (A point is 1 percent of the loan amount.)
Borrowers pay interest only on the construction funds disbursed, they do not pay down the principal, explains Bowen. The interest charged is higher than the prevailing mortgage rates, with rates early this summer ranging from 7.5 to 9 percent, says Bowen. (A normal, conforming, 30-year loan currently is running about 7 percent.)
Not all mortgage lenders will make construction-perm loans, because they require special expertise, notes Dave Ledford, staff vice president for mortgage finance at the National Association of Home Builders. And borrowers won’t qualify for one, adds Perlmutter, unless their credit record shows a good payment history and low credit-card balances.
It can be expensive just to get the loan approval before construction begins. There are the points and then the closing costs, which typically total anywhere from $1,100 to $2,000 and more, says Bowen. Unless construction costs are bundled into the construction-perm loan, as is now common, the borrower pays closing costs twice: once to start disbursing money to pay for building and again when a final mortgage is issued.
The really pricey aspect, however, is having the architect draw up the blueprints and specifications. It’s not uncommon for the high-end customers of Barrett Design and Construction, Highland Park, to spend a year shaping all of the design elements with an architect and painstakingly poring over seemingly superfluous details, such as the placement of an electrical outlet, says Mary Handelsman, controller at Barrett.
Sweating the small stuff can augment design costs, but making changes is more economical on a blueprint. “Any changes (during construction) are a lot more expensive than you think,” say Handelsman. “Changing a little floor outlet, for instance, you are looking at $50. And people say, `Well, that’s a $4 part.’ But (to make the change) you are calling in an electrician, a painter and maybe a plasterer.”
To be sure, price is not much of an object to many custom home buyers who spend a half million dollars or more. It’s not unusual, say builders, for some upscale buyers to fund construction with cash. Whether raiding savings makes sense “depends on what lenders are charging and how much the borrower could make on his money (in an investment),” notes Bill Steele, financial editor at Mortgage Market Information Services, Paoli, Pa.
One of the delineating features of a custom home is that the buyer is shouldering the costs of construction. In the semi-custom universe, the procedures can vary. “In some semi-custom developments, builders may ask you to finance the construction,” says Ledford of the NAHB. Often, however, the builder asks for a down payment when the buyer signs a contract, and at that time also requires him to be approved for the final mortgage. “We have a requirement that buyers must get into a lender as soon as possible,” says Phil Walters, general sales manager for the Cambridge Cos. “We want to know if we have a firm deal within 30 days from the time they sign the contract with us.”
The process is similar to buying an existing home: Sign a contract, put down 10 percent earnest money, and seek a mortgage.
The hitches that semi-custom buyers face, though, are that the builder may ask for a 15 percent or larger down payment, especially on an expensive home. It may take several months or more to construct the house, and the buyer usually hasn’t sold his own home yet; so he can’t use the proceeds from the sale of his home to fund the down payment. Also, the buyer is applying for a mortgage months ahead of the time he’s actually going to close on the loan. Who knows what mortgage interest rates will be like then?
Buyers of tract homes face similar dilemmas. It’s typical for a builder to refer buyers to a list of lenders. As long as a buyer checks that a builder-recommended lender is offering mortgages at competitive interest rates, there’s nothing wrong with selecting that lender, says Ledford. In fact, the recommended lender is probably skilled in ironing out the problems buyers in new developments encounter.
In some instances, large building companies may actually have a mortgage brokerage division. Again, as long as rates appear competitive, there can be advantages to borrowing from an entity determined to smooth some of the glitches in new construction financing, says Ledford.
Mark Elliott, president of Elliott Homebuilders, a Morton Grove-based custom and semi-custom home builder, says he routinely refers buyers to a couple of lenders, with the referrals varying according to where the development is located. “I’ve seen lenders try to tailor financing to an individual, just as we (builders) try to please buyers by customizing a house as much as possible,” says Elliott. “The mortgage people can usually find creative ways for the buyer to tap the equity in his current home to come up with the down payment.”
When Dave and Lisa Tramblay recently bought at Cambridge’s Southwind development in Huntley, Dave says that the recommended lender’s familiarity with the building and developing process provided both peace of mind and a savings on the mortgage rate.
“The house was supposed to be ready in August of 1997, but because of water purity problems, the date kept getting pushed back. There was nothing the builder could do, because it was the community’s problem and there ended up to be a five-month delay,” explains Dave. “I was panicky and wanted to lock in a rate that summer. But in August the lender said to hold off until I got more confirmation from Cambridge. He later called me when rates were down and told me it was a good time to lock in. It turned out to be the lowest rate ever.”
Indeed, buyers often pay between one-half to one point for the priviledge of “locking” or securing a mortgage at a specified rate at a future date, says Bowen. Since interest rates have been generally low, many buyers have been forgoing locking in a rate in recent years, he adds.
Builders can go a step further when making a lender recommendation when they’re helping financially strapped or first-time buyers find affordable financing.
In Sundance Homes developments, for example, a $3,000 allowance is regularly allotted to each buyer to use where he needs it most. Some may elect to receive a furniture allowance, or reduce their purchase price, explains John Aiello, director of marketing. Buyers who are trying to shoehorn themselves into affordable monthly mortgage payments can elect to have Sundance use their $3,000 allottment to “buy down” an interest rate by paying a lender points upfront. In other words, with an upfront cash payment, the lender can reduce the interest rate by a half percent or so, which can save the buyer enough each month on his mortgage payment that he qualifies for the loan.
Aiello says that Sundance also earmarks homes in many of its developments which are eligible for no-down-payment Federal Housing Administration loans. That’s a common practice of many builders who court the first-time market, says Ledford.
Concludes Tramblay: “I’ve been through it before (getting a mortgage) and it was a nightmare. So I was hesitant to do it again. But if you get a good loan officer who’ll give you good service, you should be OK.”
