Personal Financing for Residential Clients
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BUILD opens up the vault on recommendations for construction financing.
Some of our clients have the financial means to largely pay for their projects with available resources (or “cash” as it’s called). This makes the financial equation of building a home straight-forward and convenient (it also makes us, as financially leveraged architects, rethink our career choice). Lately, however, we’ve noticed a returning trend here at the BUILD World Headquarters; that many current clients are using construction lending to finance a large portion of their projects. Our sense is, with interest rates still very low, construction (and mortgage) lending is attractive. As the saying goes, money is cheap right now.
Regardless of how our client’s are paying for their project, we pride ourselves on putting our client’s resources to good use while achieving functional and elegant designs they’ll enjoy for many years. It’s also our intent to do everything we can to see projects get realized — whether the efforts are focused on design, construction or even finance. (We don’t call ourselves BUILD for nothing.) Given the importance of this topic, today’s blog post is a short course on construction financing. Take this information with a grain of salt, we are not lenders and have earned our limited amount of economic understanding from the School of Hard Knocks (SHK™). While this is just our overview of how we’ve seen construction lending work, we’ve seen it in action time and again. We’ve also recently taken on (another) personal project that relies on financing and, with skin in the game, our knowledge and insights are being put to real world tests. (More on this project in a future post.) Here’s our construction financing 101 course:
The most useful loan we’ve encountered is the one-time-close (OTC) loan that covers the majority of construction costs, and automatically converts to a permanent mortgage once the project is complete. If you are considering new construction or a substantial remodel, this is the loan to know and ask your bank about.
Benefits of the OTC loan
An OTC loan only involves one set of fees for what is in essence, two types of loans built into one package.
Banks that offer an OTC loan are familiar with construction lending and the many variables involving design and construction.
The permanent mortgage rate locks at the time of loan closing (even though there is likely some 5-9 months of construction before that mortgage goes into effect).
We typically work with Washington Federal for clients who want an OTC construction loan and permanent mortgage. WaFed continued to offer the OTC loan over the past several years when all other construction lending seemed to vanish or become difficult to obtain and they earned our loyalty. Even though the market has significantly changed since then, WaFed still offers desirable terms and we’re currently using them for the personal project mentioned above.
Typical Construction Cost Breakdown
While each project varies in design, scope, and cost, the numbers below achieve the caliber of work on our website. These initial numbers provide a baseline for how the lending occurs.
$25,000 Demolition, disposal, hazardous material abatement
$600,000 Construction costs at $200/sf (based on 3,000sf)
$70,000 Design fees, structural, surveyor, other consultants
$50,000 Terraces, hardscape, landscape (basic allowance)
$760,000 Estimated project costs beyond property and financing costs
These costs are typical for a general custom home in the greater Seattle area. There are many factors including scale, location, site conditions and particular client requests, but most of our projects are ±10% of this breakdown.
Typically, lenders will lend either (up to 100% of) the anticipated costs of the project or some percentage of the appraised value of the project, whichever value is less. The value also depends on a variety of factors including the specific lender, financial standing of the client, the amount being lent, etc.
Typically, the OTC financing covers about 80% of the projects we’re involved with; the balance is then paid out-of-pocket by the client. In this vein, clients typically have some equity in the property and pay for items directly like the survey, permits and design fees. Sometimes, when a client has significant equity in the property, they may pull some of that equity out of the property and use that for other project expenses. Regardless, in our experience, the bank lending is focused primarily on paying off the balance of the property cost and the construction costs themselves.
Clients tend to contact us very early in the process, which is a good move if construction financing hasn’t yet been secured. We can often guide clients to a lender we have a good relationship with so they get pre-approved before we embark on a project. With a reasonable understanding of a client’s goals, we can pencil out preliminary costs that can then be used as a basis for starting the loan process (furthering what we’ve laid out above and tailoring costs specifically for their intended project).
The client works directly with the lender to sort through the paperwork, the process, and to get the loan ready. We help a client put together the general specifications, anticipated costs and other supporting documents that the lender needs to complete the application. From that point, once the construction permit is applied for and becomes available, the loan can be closed and construction can begin in a matter of days.
From that point, the project team works with the lender during construction to have monthly draw values released that correspond to the level of work completed, and typically installed on-site, over the preceding months. Once again, having a good relationship with the bank and its representatives is key for timely draws and subsequent (prompt) payments to vendors to keep the project on a smooth course.
This system is an efficient means of financing construction and we’ve had good success with it on a history of projects. Knowledge is power and these data-points can effectively save time, save money, and save sanity.
Cheers from Team BUILD