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California Home
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The 3 Most Common Ways to Finance Home
Construction
by Reily Kirkpatrick
March 10, 2011
There are several ways to finance home construction and each
could be the “best” choice given varying circumstances. There is
not a single “best loan” to fit all situations. The three most
common methods are; a Home Equity Line of Credit, a “cash-out”
Refinance and a Home Construction Loan.
A Home Equity Line of Credit or a HELOC as many lenders referred
to it usually comes in the form of a second mortgage. They
generally have the lowest total closing costs of the three
methods and you can borrow the funds on an “as needed” basis
rather than as a lump sum. However, HELOC’s are limited to your
home’s existing equity without regard to value added by new
construction. This type of loan usually involves a rate that can
change monthly and is based on one of the more volatile indices
like the Prime Rate or LIBOR. This may be favorable in stable
economic times for a short number of years, but is considered
risky when the economy begins advancing and rates start to rise.
A “cash-out” refinance also draws excess equity from your home
by refinancing your current mortgage and increasing the balance
beyond what you currently owe. The extra funds are known as
“cash-out.” This provides a lump sum that can then be used for
construction. The attractive features are that you can obtain a
long term fixed rate with set monthly payments that will be far
more affordable over the long term than a line of credit.
However, you’ll be paying closing costs based on the entire new
loan amount rather than just the amount of funds used to build.
Unfortunately the loan is based on your home’s current equity
without regard to the cost of construction, which quite often
provides just a small fraction of the funds required.
Construction or renovation of a luxury home usually comes with a
price tag lying far beyond the savings of most homeowners or
equity currently available in their home. The true value of a
home construction loan begins with a loan amount based on the
Future or “As-Completed” value of the home. Homeowners Tim and
Kimberly Peterson of Pacific Palisades, California put it well
when they said, “we found it astonishing that we were able to
borrow the entire cost of construction and also include the cost
of very expensive architectural plans. We assumed we would need
to liquidate and use thousands dollars worth of investments in
order to have our home built. By choosing the Single Close loan
where the loan amount is based on the future value of our home
we were able to keep our well-placed investments hard at work
while we built our dream home.”
There are two primary types of construction loans; the
construction-only and the Single Close or One-Time Close (OTC).
The construction-only loan is less attractive, but oddly, the
more common. The Single Close is really the premier loan with
which to finance home construction in America today and the
savings can be huge once you know what to look for.
If you know what to look for the savings can be huge and the
Single Close provides so many advantages, including cost
savings, ease of process, financial control, accountability and
risk management.
Each time a mortgage loan is originated there are costs
associated with it that often run several thousand dollars;
appraisal, title insurance, escrow fees, lender fees and more.
These can often total 1-3% of the full loan amount. With a
Single Close or construction-to-permanent (CTP) mortgage the
process is simplified and the savings can be quite large. Not
only are you eliminating the need for a second or third set of
fees, but you can often lock-in a single interest rate before
construction begins. James Simon of Los Angeles, California
recently shared this; “it takes me nearly past the edge of
comprehension to think I almost settled for a construction-only
product to finance building my home. My home was to take 18
months to complete and I was told the only loan available would
mean I couldn’t lock-in a permanent rate before my home was
complete. However, by choosing a Single Close loan and locking
my permanent rate before construction begins I am certain I will
have saved several tens of thousands of dollars in interest.”
A Single Close loan also greatly reduces the risk of financial
loss. It ensures funds borrowed are disbursed to the builder and
suppliers only after a specific portion of the work has been
completed, properly inspected and the necessary lien waivers
have been collected. This process of Fund Control is a series of
steps that act as checks and balances aimed at reducing the
chance of your loan proceeds to be improperly diverted or have a
Mechanic’s Lien placed against your title for non-payment. Marc
Metzger, owner of Granite Loan Management in Denver, Colorado
shared a true story on the value of Fund Control; “in the normal
course of a pre-release draw inspection for a 2nd
home being built in Park City, Utah our inspector found slate
roofing tiles valued at $34,000 were missing from the
construction site. Upon further checking it was learned the
builder had re-routed delivery of the materials to his mother’s
home. His intention was to re-roof his mother’s home at the
borrower’s cost and claim the materials had been stolen. Not
only were the materials recovered, but a dishonest builder was
found out and replaced before an even larger problem could
rise.”
The Single Close loan and its carefully designed set of
procedures provide the premier way to finance most large size
home construction projects, including ground-up construction,
complete demolition and rebuild or major renovation and
addition.
Written by Reily Kirkpatrick
March 10, 2011
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