Financing a custom home is a complicated process. What are the best loan options? Where does a mortgage come in? We’re here to help answer those questions.
The most common form of custom home financing is a construction loan. It’s important to make informed decisions before submitting an application, because the process is often a complicated one, and any misstep can affect the funding methods, as well as the cost of your final mortgage.
A construction loan has a few unique features from other types of borrowing. The primary difference is that a bank’s security is being created as construction progresses. Instead of a project being approved and given one chunk of money, the bank will usually parcel out the funds as the construction progresses and to-do’s are checked off.
Where does the process start?
Initially, the bank will require several things to provide them with a clear picture of the project.
To evaluate the value of their security, they will need an appraisal of the value of the finished product. To accomplish this, they’ll need a plan and a detailed description of the materials that are to be used in the construction.
There are often other requirements related to having a viable property to build upon — again, to make sure the property provides proper security for the loan. A few examples of this are proof of potable water, approved septic design, or available sewer connection.
Most construction loans require 20% cash or equity. Owning the land free and clear goes a long way to fulfill that requirement.
Where does my contractor come in?
Often, the lender will have a vetting process for the contractor. They will require a copy of the contract, which will need to include the total cost of construction and a completion date. During this process, a contractor’s registration and current bond are verified, and other professional documents such as a resume, financial statements, trade contractor and previous owner references may also be analyzed.
The loan is funded through two different methods:
The first method is a voucher system
, which involves filling out what is essentially an extensive check book, in which each individual cost must be requested to be reimbursed by the bank. It’s a tremendous amount of paperwork, and is so cumbersome that it is rarely used.
The vast majority of banks prefer to use the construction progress draw method
, which is created from a form supplied by the lender. On this form, the total amount of the construction cost is spread across several work stages such as foundation, framing, electrical, and so on. Through this form, the loan is funded as construction progress is made.
Typically once a month, a construction draw request is submitted by the builder that indicates which work stages have been finished. The bank then sends an inspector to the job site to verify the work stages are indeed complete. The draw is then signed by the owner and the builder, prior to funds being released. Once the inspection is done and the paperwork has been signed, the bank will supply the next stage’s allotted funds — usually to the builder’s company, directly. This all typically happens within the first five days of the month.
Normally on the last draw, the bank will require a certificate of occupancy prior to releasing the last of the funds. The certificate of occupancy is often also the final inspection from the municipal building department.
What happens after my home is finished?
After the home is completed and final draw is complete, the next step is the conversion to a mortgage. The most efficient and cost-effective way to accomplish this is to have chosen a “One-step” construction loan from the beginning, which converts the construction loan to a mortgage automatically. If you did not choose a one-step loan, additional bank fees will likely be charged to convert the construction loan to a mortgage loan.
Where should I request a construction loan?
In most cases, the best providers for a construction loan are local or regional financial institutions, rather than state or national banks. Local banks have familiarity with the local real estate market, more familiarity with the local jurisdictions and have a better understanding of what is required for the property to provide the proper security, as well as the local personnel to perform the required draw inspections.
It’s a great advantage to work with a professional builder that can provide the lender with an organized and complete loan package. An established builder will have working relationships with local financial institutions, and can provide you with guidance in selecting the right lender. Some of the best builders even have their own vetting process for the local financial institutions, and can provide you with an approved lender list.
Estes Builders is an award-winning design build firm that specializes in custom homes in Western Washington. We have earned more than 130 customer testimonials and a reputation as Western Washington’s most trusted custom home builder. We build custom homes in Sequim, Port Angeles, Port Townsend, Port Ludlow, Bainbridge Island, Kingston, Silverdale, Port Orchard and surrounding areas. Contact us for a FREE Project Analysis to discuss your project.