Dollars and sense: Part 1 of 4
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A critical first step in building a house is building a budget. A budget helps you answer the question: What can I afford to build? You need to look at your budget from four perspectives: your finances, what you can build, what your location will support, and what the bank will give you. Yes, these four perspectives intertwine, but it's important to consider them individually as one perspective may be whispering "Yes! Yes!" while another is shouting "No!!!"
Part 1: Your finances
The financial perspective is simply answering the questions: How much can you spend? and What financial fallbacks do you have if everything goes to Hades in a hammer holster? On what you can spend, you need to identify what cash you are willing to bring to the table(saw), what equity, if any, you have, and how much of a loan you can afford or are willing to apply for. The cash you can bring to the table is simply what you have saved that you are willing to allocate to the project. If you have nothing, you are already in trouble. You are going to need lots of cash for a down payment on land, to pay up front pre-loan costs, and to support an efficient and timely build.
On estimating equity in your current home, be conservative and be sure to subtract off the closing costs and any other costs associated with selling. You may even want to factor in moving costs if you are so (ahem) moved. When estimating equity, you can look to see what your tax appraiser thinks your property is worth (generally a conservative estimate), peruse the paper or open houses for comparables or, if you already have an agent, get actual comparable data. If you plan on selling later in the process, closer to the completion of the new house, you'll also need to consider what the market might look like then, generally a year down the road or more.
I'm generally shocked at how much a bank will loan you based on your salary (seems to be about three times your annual pay). If you are young and/or expect your salary to grow, you may want to stretch a bit on the loan. If not, think carefully about how the final house payment impacts your lifestyle. And if you are in a high property tax state like Texas, be sure to also factor in prop taxes which can easily add 500 to 1,000 dollars a month (!!!) to your monthly home costs.
It's also a good idea to consider your financial fallbacks in case things go awry during your build, such as unexpected increased costs. These fallbacks may be other savings you are not willing to put toward the project (but could if forced) and retirement savings in 401Ks and whatnot. Sounds scary (I would never recommend robbing your retirement), but you need to know. Having no financial fallback is scarier.
So your financial perspective looks like this:
- cash to apply to the project
- equity you can apply to the project
- loan amount you are willing to pursue
- amount of financial fallback funds
The first three items added together is your project budget. The fourth item is insurance.