On our website you will see that establishing a budget for your custom homebuilding project is the first step in moving forward. The second is contacting the homebuilder and these two steps actually correlate really well together for this reason. A homebuilder will be familiar with local labor, material, and other related costs for construction projects. Additionally, their company will be able to work with you and the architect to design the plan you want in the budget you’ve established. Now, there are two methods to funding a new custom home project:
Option #1: Pay For Your Home Out of Pocket
Whoa! Hit the brakes! You want me to buy a HOUSE out of pocket.
Lower the pitchforks. It’s just a suggestion. It may not be the most common route, but let me encourage you by saying it happens more often than you may think. You don’t have to be tied to a monthly mortgage at all if you choose to save diligently, list your existing home at a competitive price, and shop around for the best deals on land.
There’s also no real question of what can I afford in a monthly payment or who has the best interest rate because it’s all out of pocket. There’s just, “We have saved for this point in our lives and are ready to move forward. This is what we are comfortable spending on a home, and these are the amenities we need. Help us design a plan that works with this number.” Best of all, when the keys hit your hand at the end of construction, you own it! And there is nothing quite as liberating as home ownership!
Option #2: Finance
So, the second option is obviously financing the project. When you speak with a lender about opening a construction loan, you will have to provide documentation that will help them determine the maximum amount they are willing to lend you. This often includes check stubs, tax documents, financial statements, etc. Using this information, the lender can prequalify you for the top dollar available for your new home construction.
They will also need a copy of the plans for the home you would like to build and the location that you would like it to be built at. Given this information, the lender will order an appraisal on the plans to establish a value for the project. The construction loan amount will typically be 80-85% the amount of the appraised value. This is regardless of what you prequalify for. Let’s run through a sample:
Jack and Diane are two American kids wanting to build a house. They have been prequalified for $325,000 and would like to build a 3,000 heated square foot home. For simplicity’s sake, we’ll say their projected value is appraised at $100/ht.sq.ft. or $300,000. The bank they are dealing with agrees to lend 80% of that appraised value or $240,000.
$300,000 x .80 = $240,000
Notice, though they prequalify for more, they are only being lent 80% of the value of the project. This is a common misconception. Just because you prequalify for an amount does not mean that it is the amount you will be lent.
So, we understand a little more about how lenders view the project, but what about personal finances? What is reasonable and logical for a monthly mortgage?
Referring to some Dave Ramsey principles, a home mortgage should not exceed 25% of your monthly income. Most sources place median U.S incomes in the mid to high $50,000’s. Again for simplicity, let’s just say you net $60,000 annually, or $5,000/month. Let’s do the math.
$5,000 x .25 = $1,250
This means if you make $5,000/month, your monthly mortgage payment should not exceed $1,250. Don’t forget the interest, property taxes, escrow, insurance, etc. that is rolled into the monthly amount.
Additionally, Ramsey advises not financing a home for more than 15 years and ONLY at a fixed rate! Don’t you touch that variable rate…stop it!
So… “How do I know what the right homebuilding budget is for me?” No one can tell you what to do with your money. But if you’re looking for some objective advice to help establish a dollar amount, you can’t get much better than that. Build a home, not a prison. Look those numbers over and when you’re ready to build, visit our website at www.gustafsonproperties.com. You’ll find plenty of helpful information and can contact us at anytime with questions!
*“5 Steps to Buying a Home That Won’t Bust Your Budget.” Home Buying, Ramsey Solutions, https://www.daveramsey.com/blog/5-steps-to-buying-home-wont-bust-your-budget