Building a House in 7 Steps | Step 5: Financing

Step 5 of the series: how we finance a build, from the loan we ask for to the way the lender releases funds.

Step 5 of the seven step series. We push people to build a personal house first for one reason: the financing is dramatically better than anything on the investment side, which makes the cash on cash return higher on a smaller check. Here is exactly what a construction to permanent loan needs from you.

Start with the pre-approval and the right loan product

Go to a local community bank. Very few commercial lenders write a 95% loan to cost construction product, and that is the product you are hunting for. Names vary by bank: construction to permanent, builder loan, owner builder loan. What matters is the 95% loan to cost.

Loan to cost means exactly what it says. A $100,000 lot plus $300,000 of construction is $400,000 of cost, so a 95% loan is $380,000 and you bring the $20,000 difference plus closing costs, call it $8,000 here. The rule of thumb is 5% down and 2% to 4% closing, so plan on 7% to 10% out of pocket.

You can borrow someone else’s experience

The lender wants construction experience on the file. If you do not have it, that is not a wall. Hire a builder on a cost plus contract, typically a 10% fee, so $30,000 on a $300,000 build. The fee goes into the loan, he manages the project start to finish, he hands you receipts, and the contract between you and him is what lets you qualify on his experience.

The four documents the bank wants

1. 01

   An itemized construction budget

   Start from square footage times cost per square foot, then get real bids. On a 1,500 square foot home at $150 per foot that is $225,000, plus a $25,000 builder fee. The bank hands you a blank spreadsheet and you fill in foundation, framing, plumbing, and every other line with your builder.

2. 02

   The full construction plan set

   This comes straight out of step 3 and step 4, with the site plan approved. The appraiser works from it.

3. 03

   The spec sheet

   How do you appraise a house that does not exist? You describe it. Foundation type, flooring type, windows, heating system, finish level. The appraiser uses that to run comparables and stamp a value.

4. 04

   Your financials

   Tax returns or W2s, and a credit score around 680 or better. A co-signer with a stronger score works too. We have seen that route close plenty of times.

Then the appraisal decides

The appraiser values the house from the plan set and the spec sheet. If the value supports the 95% loan to cost math, you are clear to close and you break ground. That is the handoff into step 6.

Watch more on Arthur's channel.

Common questions