How do normal people pay for custom homes on land?

May 30, 2009 4:27 PM

Dream Home Filter: How does one go about financing the buying of land and building of a custom house? I need help with land loans vs. buying land with a house on it (to improve/tear down), construction loans vs. home loans, etc

I've always wanted a couple acres of land and a custom designed house with a kitchen that works exactly as my family wants it to, etc, but I've never known anyone that did it directly (I know a few people that came into money and paid cash for new custom homes).

I understand from a bit of research that you could get a loan for the land you buy, then a construction loan to build a house, and when it is complete, it can be rolled over into a standard home loan, but I've heard the land loans are hard to get and the construction loans are high interest rates. I've been told by some people that buying land outright is the only way to go, but I don't have a few spare 100s of thousands of dollars to do that.

Let's say I currently live in a home worth $300k, and I'd like to someday build my own $200k custom home on $100k of land (keeping my current house until the new one is done, then putting it on the market). Are the loans necessary to buy land and build a house tough to get with a lot of interest? Is buying land with a manufactured home on it that could be removed be a better way to go?

posted by mathowie to home & garden (9 comments total)

I would encourage you to contact several banks, make an appoint with some one in residential lending ( not personal or commercial lending) and pose the questions. Take along some up to date financial information and lay out your plans, goals, uncertainty and finances. If you have good credit and a responsible borrowing history I would be very surprised if you were not welcomed and come away much better informed. Go to at least two financial institutions, hopefully one where you have established a track record. Remember, banks only make money when they lend and right now is a borrower's market if you are a good candidate. This is a complicated question but I do believe you laid out a fair representation of the process--your lack of proven history will be a draw back. I have a very strong hunch since the "project" has built in uncertainty--this will hinge on your financial stability and integrity. Since you are not a professional builder I would expect any lender to require substantial equity and want clear evidence of progress as you draw down the building loan.
posted by rmhsinc at 4:43 PM on May 30

Sorry for the question...but something BIG that factors into this is your current home (worth around $300K, you say).

1. Is this your appraisal or a professional one done recently?
2. Is your current home mortgaged or paid off?

If the answer to #1 is "yes", continue to the next question, if not then you know what you gotta do.

If the answer to #2 is "paid off", then you should have no problem (with the banks) using your current home as a type of collateral to start your new home.

As for the difference in rates, it has to do with time. Construction loans are loans made to finance construction (usually made by developers, and sorts). Once construction is done, the loan CAN be paid back. Its high interest because its a short-term loan compared to a home loan (which can last up to 30 years). Banks gotta get their dolla one way or another with a short-term loan.

If I were you, I'd go to a bank you have been doing business with for years (even if its your freaking debit card), tell them about your current house, tell them about your plan, and let the loan officer figure out the best way to disperse the money for your project. Actually...go to a few banks that you have a relationship with and do this. See who offers you the best deal and stick with that person.

Unfortunately, this may not be the best project to figure out online as different banks have different criteria...and that isn't even getting into different loan officers.

Good luck on your project.
posted by hal_c_on at 5:30 PM on May 30

What a coincidence! I'm going out to dinner with a good friend who is a residential real estate developer. I know he has been looking at both building a custom home on brownfield and greenfield properties. I'm looking to do it also (which is why we're going to dinner ...). The reasons the loans are higher is because you are not a design-builder and building a custom home is fraught with a lot of liabilities. As the bank has no legal remedy to keep you from issuing change orders and running the project to the ground, their only recourse is to demo the building and sell the land, ergo a speculative loan on their part.

I believe the way to get around some of the financing issues is to go with a custom home builder who holds a surety bond on the project (or some sort of similar instrument) and if you become insolvent the risks are mitigated to the bank, and the builder. Of course this is an additional expense, and it comes down to which type of financing is cheaper and fits what you want to do.

I'll print out this question and bring it with me and let you know what he says.
posted by geoff. at 5:42 PM on May 30

I believe that you are mostly correct in your assumptions. I think that you have to get a loan for the land, and then get a separate construction loan. Construction loans aren't standardized like regular mortgages because the lender has to know the project and the details before they will approve a loan. I found a good description of the process here and here . This bankrate answer is also good.
posted by bove at 5:56 PM on May 30

I don't know if you're in a position to do this, but one approach is to sell your current house and temporarily accept a more basic standard of living so you don't need to borrow as much.

Example: I fixed up and sold my city house. I bought land outright with the money I made from that. I put an inexpensive mobile home on the land, which I lived in for several years before I built my custom house.

Living in a paid-for mobile home on paid-for land is extremely cheap. Imagine how your income would pile up if you didn't have your mortgage or any rent. That pile of money would reduce the amount you'd have to borrow to build a house.

Also, for me, living in a trailer for awhile showed me that I didn't want or need to build a big house.

For what it's worth, I used savings + a moderate inheritance to build the house. If I didn't have the inheritance, I would have borrowed about $60k.
posted by PatoPata at 6:04 PM on May 30

While we were building it my place had a construction loan and a land loan from the same lender, and it did indeed roll into a conventional mortgage with a rate we'd agreed at the start of the project. We ran the project. If you run the project you want to keep a gate between the money and the contractor - that is, you want to be in a position to approve the expenditure of money during the course of construction since you pay this in installments at agreed milestones (for example, passes plumbing inspection).

My project had some unusual conditions, though - it took so long to get Pacific Flicker & Flash to put the electricity in that the whole place was built using power from a generator.

We lived in a trailer on the property from May to early July after we sold our house.

Email if you like.
posted by jet_silver at 6:27 PM on May 30

Just got back, unfortunately he was not aware of any other financing schemes except for the one you describe. He said that, indeed, this was an activity for the rich or the very motivated who want to become their own contractor. He also said that your best option would be to sit down and figure out exactly what you want, what you need, and finding an existing house to fit your needs. That you'd be surprised what you a good contractor can do to an okay house, and if it means knocking out walls or bringing a room down to its studs, this is always going to be cheaper than a demo down to the foundation.

Furthermore he said that doing things "just as your family wants," is in general, to him, the sign that it is going to be very expensive and that clients who phrase things in such ways usually face all sorts of cost over runs. But of course he deals with custom homes starting at least $500k where the disposable income and budgets are greater and presumably without internal controls.

He is also building a home, and as a builder, he's currently bidding on a home he wants to "redo completely" but that means keep the current foundation and layout, bringing it down to studs and taking out walls if he needs to. He says that very few properties are going to be worth it to tear out a foundation and build a completely new house.
posted by geoff. at 8:50 PM on May 30 [1 favorite has favorites]

I have friends that recently custom built their dream house. First, they already owned another house that was completely paid off (they have owned it for twenty-five years) worth $250,000 and had been lived in by renters (who essentially paid the mortgage). They purchased another house about twenty years ago, sold it about five years ago at a huge profit and purchased a third house for $300,000 with a minimal mortgage. After a few years of renovations they realised they wanted to tear the house down and build new. So they got a mortgage on the first (previously paid-off house) as well as a small construction loan and had the house built for around $300,000 while living rent-free at her parents house for 18 months. They now own the two houses, still renting the first to pay the mortgage and the remainder of the construction loan. They plan to sell the first, older home at some point to completely clear the mortgage but aren't in a big hurry. Other people that have had custom homes built have had inheritances. So yeah, it is a rich man's game.

Unless you have an extra house waiting in the wings what I would do in your case is focus on accelerating payments on your current house to have it fully paid off. I doubt land prices will rise significantly in the next few years. When your current house is paid off you can re-mortgage it (for a reasonable percentage - not 100%) and use the funds to purchase land and build your dream home. Then sell off the older home to pay off the mortgage. Will this take years? Yep, but unless you are independently wealthy you have to plan conservatively with your money and don't get more in debt than you can handle.

Good luck!
posted by saucysault at 7:45 AM on May 31

My father-in-law is a high-end custom home builder, so I've seen this process many times (including my own home). Basically, a person will buy the land outright. As you said, getting a loan for unimproved land is quite difficult because lenders don't like that risk. You can then use that purchased land as collateral for your construction loan, which in our case was interest only for the duration of the project. While it tends to be a higher rate, there really isn't a better way to do it, unless you're sitting on piles of cash. And even then people will often get a construction loan because they feel they will make more on other investments rather than putting that much cash into the home.

On a side note, I don't know if you pulled those numbers out of nowhere, but it would seem quite improbable to build a home worth 200k on land worth 100k. The only way I see that is if you are building a moderate home on substantial acreage. In my area, at least, land that sells for 100k is generally for homes about 500-750k or more. Your area may be entirely different, of course. (On preview, I know nothing about Oregon real estate, so feel free to disregard this section).
posted by shinynewnick at 10:23 AM on May 31