Top Pitfalls When Building a Home
I’ll confess something: when I was new in the business, I used to lie to my clients. I had tried to originate one construction loan for a friend, and it was such a mess that she rightfully decided to go with another lender, and from then on I would tell my clients that the company didn’t offer construction loans and refer them to someone else. We offered them, but we were bad at them! Later, under the mentorship of a true expert, I learned how to do construction lending without raising everyone’s blood pressure, and they are now some of my favorite loans to work on.
Building a custom home is a labor of love. I frequently compare it to actual labor: you’ll hit a point where someone is yelling that they can’t do it anymore, they hate everyone who allowed them to end up in this situation, and they’ll never do it again, but 3 months later it’s all forgotten and the end result is worth it. There are a few common pitfalls that I see that are avoidable, and can help you have a better experience:
Appraisal issues: you’re building a custom home because what you want isn’t available on the market. Obvious, right? However, appraisers rely on comparable sales to determine value, and banks rely on appraisals to determine how much they will lend. Be aware that if you are building something that is unusual, you may have the appraisal come in lower than the cost to construct. Your new indoor basketball court is really cool, but you’re probably paying cash for that part.
Taxes and Escrow: If your permanent financing (the part of your mortgage after your home is complete) includes an escrow account to pay your homeowners insurance and taxes, the initial money to make those payments will need to be funded into the account before the payments are due. This often means that right at the end of the build when you want it to be over, you get a surprise bill from the mortgage company for your new homeowners insurance policy and the expected taxes. Make sure to budget for those expenses!
Going for the low bid: When choosing your builder, make sure to compare the bids and look at where the costs are higher or lower. Ask your builder which line items are allowances, or estimates for what a third party will charge for which you are responsible for any overages, and which are fixed costs. I once had a client building a 1.2 million dollar home with an estimated $4500 for appliances. I gently suggested to the clients to pick out appliances and compare to the estimate, and go into it with the understanding that there may be other line items that are similarly underestimated. If the lowest bid relies on underestimating things that will be your responsibility when the bill comes in, it’s not really a bargain.
Expecting the timeline to be real: Look, I know we all want to believe in magic. I am sure someone has built a new home in 6 months, but it’s never happened in front of me. Most counties have public permit portals. Pull your builder’s prior permits and see how long those homes took from when the permit was issued to when the certificate of occupancy was issued. Plan on things running late. If your construction loan has a 12 month build period and your builder has a 12 month construction timeline, ask your lender what happens if the home is not complete.
Building with Cash: Being able to fund your home build out of pocket is a huge accomplishment, but keep in mind that getting a construction loan on a project that has already started is exponentially more difficult and typically more expensive. In-process homes are a risk to the lender for mechanic’s liens popping up that impact the equity in the home, and high credit card balances will impact your credit score. Combine that with going from a lot of money in the bank to little or none, and your A+ scenario at the beginning of the build is now high risk. You only pay interest on the amount you draw from the loan, so get the loan up front and if you don’t need it, then you don’t need to draw on it, but if you do need it, you have a safety net.
