Dollars and Sense: Part 2 of 4: What you can build
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Previously, I posted about defining your finances. The second budget perspective you need to investigate is what you can build with your budget. Doing this requires looking at what it will cost to bring your house home. The primary categories here include:
- carrying costs
- loan costs
- soft costs
- hard costs
Land is easy enough: How much did your land/lot cost, including closing costs? or: How much are you budgeting for your land/lot? The other thing to think about is carrying costs for the land. If you financed the purchase of your land, how much will you spend on payments until the house is completed? Also, how much will you be spending on property taxes? If these payments are coming out of your cash reserves, then you need to account for them as well.
The construction loan includes the closing costs and the carrying costs. For closing costs, you can assume 4 percent of your anticipated loan amount. Carrying costs are what you need to pay on the construction loan during the build. Construction loans typically work on the draw: You only pay interest on the money you draw from your loan. Depending on your finances (and your loaning bank), you may be able to carry these costs yourself. However, banks may require that the carrying costs, called the "interest reserve", be built into the loan. To estimate these costs, multiply your construction loan amount by 0.60 (to account for the draws over time) and then by your interest rate.
Hopefully you are planning on and can get a single-close construction loan. With a single-close construction loan, you close once and have the construction loan and the final financing of the house taken care of in one two-birds-with-one-close throw. In a double-close situation, you close on the construction loan and then, when the house is finished, you finance the whole project and close again. If you plan on a double-close, you need also plan for those additional closing costs.
The division between soft costs, hard costs, landscaping, and gewgaws (my term for nonstandard options for the project) will vary depending on who (architect and/or builder) you work with; just make sure you and the folks you work with understand what is where. Soft costs generally include everything that doesn't include actual construction costs of the house such as architecture fees, engineering fees, permitting fees, surveys, geotechnical analyses, and connection fees. You can assume that soft costs are about 10 percent of hard costs.
Speaking of hard costs, these are the actual construction costs of the house. These costs generally include time and materials to build the house, contractor overhead, contractor profit, driveway, attached decks, garage, and walkways. At this early point in budgeting for a house, it's best to assume a price per square foot appropriate for your (hoped for) finish out. If you know what size house you'd like, figuring your hard costs is simply multiplying the price per square foot by the total square footage.
As you saw above, some of the landscaping costs may be built into the hard costs: walkways, driveways, and attached decks. Talk to your builder/architect to be sure. But outside of those costs, turf, fences, beds, trees, shrubbery, unconnected decks, paths, and bird feeders are part of the landscaping budget. Depending on what you are planning, budget 5 to 10 percent of construction (hard) costs on scaping your land.
Gewgaws are what I call those extra items that go above and beyond the costs of a standard build: for example, a pool and/or hot tub, a rainwater harvesting system, solar panels, helipad. You'll just have to list these things out and estimate their cost. Don't forget installation!
Contingency is the planned pot of money you can dip into when your estimates lean in the wrong direction. Based on what I’ve read, 99 out of 100 custom homes go over budget for various reasons, so if your budget is tight, planning for unplanned expenditures is wise. And if it goes unspent by the end of your project, you can use it to upgrade fixtures, buy a sofa, or take your partner out for a cherry limeade. Our architect has pointed out that a contingency, especially if it is large, steals square footage from your project. True dat. Ultimately the size of the contingency is a function of the tightness of your budget and how well you deal with uncertainty. For us, at this point in the project, there’s a good deal of uncertainty. We don’t know how much equity we’ll get out of our current house or “exactly” how much the house will cost to build. In our case, the contingency may decrease as our certainty increases.
The bank, recognizing the fickleness of best laid plans, may require a contingency when agreeing to give you a construction loan. In this case, they will add 5 to 10 percent to the construction loan amount to ensure you don’t run out of money. But remember, if you spend this money, you’ve increased the total cost of the project and will have a higher house payment. Nonetheless, it’s good to have that money there.
There are other funds that can be used as a financial fallback if things start to go awry. For example, landscaping and gewgaws can be jettisoned from the budget later in the building process to finish the house. It’s good to know what Plan B (and C) are when building.
Because so many of these costs are dependent on what the hard costs are, I've put together a spreadsheet to calculate, ultimately, how many square feet your future house could have. What’s cool about this spreadsheet is that you can see how different decisions impact the size of your house. You want a pool? Estimate the cost, add it to the GewGaw list, and watch your square footage evaporate. Aunt Mary leave you 50 grand in her will? You can quickly see how a financial windfall, however sadly obtained, increases your square footage.
Note: If you use this spreadsheet to make decisions, use it at your own risk. I don't guarantee its accuracy, although I sure hope it's accurate because we're using it to make decisions. I'll keep tinkering with it to increase it's usefulness and usability and will post comments below about any upgrades or errors. If you find something wrong (or have a suggestion), please let me know!
Part 3: What your location will support
Part 4: What the bank will give you