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Construction Articles

Construction Financing for Custom Homes

CONSTRUCTION FINANCING

CONSTRUCTION FINANCING

 Ideally, financing your custom home is first step you take in the custom homebuilding process because it establishes your budget and helps you prioritize the “must-haves” vs. the “nice-to-haves” for your new home. There are 3 ways to finance your custom home:

  • Cash
  • Buyer-Financed Construction Loan
  • Builder-Financed Construction Loan

 Cash

 The old adage “cash is king” is not necessarily true in custom homebuilding. While cash is great to have, it does not protect the home buyer and home builder the same way that a buyer-financed or builder-financed project does.

 All parties to a construction contract should make an initial determination that answers this question:

 What happens if the other party becomes incapacitated, or unable to perform, for any reason?

 For a home builder, the loss of revenue during a construction project can have devastating effects.

 For the home buyer, the questions that need to be answered include:

 How is the cash disbursed each month to the home builder?

  • How are monthly progress inspections made?
  • How can I guarantee there are no outstanding liens?
  • What happens if the cash runs out?

 If it is a cash transaction, home builders will often require a third party to handle inspections and disbursements. Typically, a law firm will handle the transaction, and a required amount of cash must be in the construction account for disbursement every month. “Cash in fund” is typically two (2) months of construction activity. Every month when there is a draw against the fund, that amount must be replenished within 5 working days. This ensures that:

 There is always cash in the fund to pay the home builder.

  • The money is disbursed only after a third-party inspection.
  • If there are issues during construction, a third party can assist in solving them.

 Buyer-Financed Construction Loan

 Buyer-financed construction projects are the most popular type of financing. Often called “construction loans” or “custom home loans”, the key element is that the home buyer — rather than the home builder — takes out the loan. 

 Key Elements

  • The contract is a personal-services contact between the home buyer and the home builder to build the home.
  • It is not a real-estate transaction.
  • Each month, the buyer-financed loan pays the home builder only for the work that was completed and inspected by a qualified, third-party inspector.
  • Home buyers typically save significant amounts of money when they finance construction of their home. (When the home builder finances construction, the financing costs are added to the total project cost, and the home buyer ends up paying more as there are two loans vs. just one loan when the project is buyer-financed.)
  • An average savings between a buyer-financed project and a project financed by the home builder can vary between 2% to 4% of the total cost.
  • Many buyer-financed loans provide an initial “soft draw” that is used by the home builder to pay initial costs such as engineering, blueprints, permits, mitigation fees, and any commissions or franchise fees.
  • If any issues do happen to arise during construction, the bank can act as a third party to resolve the issue, and the home builder’s concern about timely payment is mitigated.

 Builder-Financed Construction Loan

 Builder-financed projects are real-estate transactions because the home builder owns the land and construction until the project is completed. Many home builders prefer a builder-financed project because it allows them to control the entire process from start to finish. If there is an issue, the home builder is in control. 

 Key Elements

  • It is a real-estate transaction.
  • The home builder controls the construction project because they are financing it.
  • The home buyer is limited to making minor changes (if any) to the home. (The home builder assumes that if their client does not purchase of the home once it is completed, the home builder will have to resell the home.)
  • The home builder’s cost to finance the project is added to the total cost of the project — and it often exceeds 4% of the contract price. (For a $500,000 home, for example, this means an additional $20,000 is added to the cost of the home.)
  • The home buyer’s mortgage to pay for the home is an additional cost for the home buyer.

We Are Here To Help

At CDAhomeplans.com, we believe in providing our home buyers with as much information as possible so they can make the right decisions for their custom home.

Please contact us to schedule a call so we can answer all your questions — it’s free, and there is no obligation. We love to talk construction!

 Call or text us at (509) 289-5305.

Todd J. Sullivan and his dog Loki in Coeur d Alene, ID

Todd J. Sullivan and dog, Loki in beautiful Coeur d’Alene, Idaho

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(208) 298-5305 TEXT me direct for Custom Construction with Sullivan Homes PNW
Categories
Construction Articles

Construction Contracts for Custom Homebuilding

CONSTRUCTION CONTRACTS

 CONSTRUCTION CONTRACTS

It’s the heart of the matter. The controlling document if things go wrong. The most important document in your relationship with your home builder

Nature of the Construction Contract

A construction contract is not a real-estate transaction. It is a personal-services contract between the home builder and the home buyer for services to be rendered.

This creates interesting differences between a typical real-estate contract that many home buyers are aware of and a construction contract.

Differences Between Real-Estate Contracts and Construction Contracts

  • Construction contracts are not recorded like real-estate transactions are.
  • As a non-recorded contract, the actual amount of the construction contract is private and not recorded in any county record.
  • Because there is no record of the value of a custom-home contract, the value is not available for appraisal purposes. This can become an issue, because custom homes are often more valuable than similar production (tract) homes, and appraisers can only access new homes that are real-estate transactions (builder-financed) for valuation purposes.
  • A savvy custom home builder has recent transactions they can provide to appraisers for valuation purposes. Failure to provide such information may result in a low appraisal and project failure.
  • Construction contracts have a specific duration.
  • Typical construction contracts range from 9 months to 2 years, depending on the project’s complexity and the home builder’s schedule.
  • For typical construction contracts, the clock starts ticking when the building permits are issued.
  • If water availability (from a well) and septic engineering must be completed prior to submitting a building permit, this can add significant delays to the start of the project.
  • If there is a delay due to pre-permitting requirements, the construction loan will start to run at the signing of the loan documents. This can create a situation where the home builder is within their contractual time limits, but the loan expires prior to project completion, and the home buyer is forced to renegotiate the loan. This results in an additional expense for the home buyer. If the construction contract is for 9 months, it is good practice for the construction loan to be for 1 year.

 Components of a Construction Contract

Although every construction contract is as different as the home builder creating it, most contracts will include the following items:

  • Recitals: Who the parties are, addresses, and the intent of the contract.
  • Contract Price: The actual contract amount which should include the taxable amount. (Taxable amounts are often broken out for the client to understand how much tax is paid.)
  • Home Builder Services: A recital that includes the complete construction of the home, what is included, and what is excluded
  • Home Buyer Responsibilities: A recital that includes the responsibility for the home buyer to make timely payments to the home builder if the lender fails in their responsibilities.
    • This clause can be an issue if the lender is not timely with their inspection and payment processes and systems.
    • Typically, the home builder submits a draw sheet for approval by the home buyer for the prior month’s work completed and then submits the signed draw request to the lender. The lender then orders an inspection, and once completed, finalizes the amount requested and approved for payment to the home builder.
    • The home builder typically submits the draw sheet at the end of the month and makes all payments to their subcontractors and vendors by the following 10thof the month.
    • If the lender is not timely in paying the home builder, most construction contracts require the home buyer to make the draw payment to the home builder after X days. The home builder is not in contractwith the lender but is at the lender’s mercy for prompt payment.
  • Allowances: The construction contract should state the key allowance categories and their respective amounts.
  • Home Builder Disclaimers: Include items that, if they occur, the home builder is not responsible for them. Common disclaimers include excavation of rock, encountering water, strikes, “acts of god”, weather-related issues, and material shortages.
  • Warranty Section: Information about how the home builder warranty works and how the product and installation warranties work.
  • Boilerplate: The legal components that make the contract viable, including jurisdiction, mediation requirements, etc.

A good construction contract is designed to define, explain, and mitigate issues that might arise during the course of construction. In case of either party’s failure, the contract provides a legal framework for the resolution of those issues.

We Are Here To Help

At CDAhomeplans.com, we believe in providing our home buyers with as much information as possible so they can make the right decisions for their custom home.

Please contact us to schedule a call so we can answer all your questions — it’s free, and there is no obligation. We love to talk construction!

Call or text us at (509) 289-5305.

We Are Here To Help

At CDAhomeplans.com, we believe in providing our home buyers with as much information as possible so they can make the right decisions for their custom home.

Please contact us to schedule a call so we can answer all your questions — it’s free, and there is no obligation. We love to talk construction!

Call or text us at (509) 289-5305.

Todd J. Sullivan and his dog Loki in Coeur d Alene, ID

Todd J. Sullivan and dog, Loki in beautiful Coeur d’Alene, Idaho

Specifications and Selections for Homebuilding

SPECIFICATIONS AND SELECTIONS Specifications & Selections  How is your house built? What types of materials are used? How are those materials installed? What decisions do you make as the home buyer? What decisions does the home builder make? These are all...

Home Plans and Design for Custom Homebuilding

Home plans and design for custom construction How To guide with CDAhomeplans.com

Construction Process for Custom Homebuilding

The construction process can be hectic and chaotic. Lean about custom homebuilding and the process of building with cdahomeplans.com

Construction Financing for Custom Homes

Learn about financing your custom home with a variety of different loan programs for home design and custom homebuilding with CDAhomeplans.com

Construction Contracts for Custom Homebuilding

Construction contracts are critical to custom homebuilding. Learn about the components of the custom construction contract with CDAhomeplans.com

Change Orders for Custom Homebuilding

The Good, the Bad, and the Ugly in Custom Homebuilding Change Orders.
(208) 298-5305 TEXT me direct for Custom Construction with Sullivan Homes PNW