How to Apply Yourself to Getting a Construction Loan
In this chapter:
Learn the importance of being pre-qualified by your lender
See how your builder goes from "dollars on the dirt" to your new home
Find out how to best prepare for your loan application
Get your credit report and discover how easy it is to clean it up
Understand your FICO score and how it affects the amount of money you can borrow and the interest rate you have to pay
See how amortization works by following an example
To find out how to download a free sample loan application, see "Additional Resources"
The loan application and prequalifying is the first and most important step in the entire process of building your home. You can't begin a conversation with your realtor and you can't discuss any plans with your builder until you have been prequalified.
Prequalifying is simply being approved for your new home loan. It's not all that simple, but it's important. The amount you are prequalified for is the total amount you can spend on your new home.
To do list
Find a good lender.
Choose the right loan package.
Get prequalified for your loan to know your "dollars on the dirt."
Find the land you want and what it will cost you.
Speak with several builders to understand what you can get for your money.
Knowing Your "Dollars on the Dirt" Before You Begin
The prequalified amount is important because it’s the amount of home you can buy. When you meet with your realtor for the first time—that is, if you have one—the first question he or she asks is "How much are you prequalified for?" If you don’t know, you have to go away, find out, and come back when you do. (For more on whether you need a realtor, see the Caution in this section.)
The total amount you can spend includes equity in the home you might be selling. That equity (the difference between what you currently owe and what your home can sell for, minus real estate commissions and other expenses) combined with the amount you can borrow determine the total budget for your new home, including the land. If you already own the land, that prequalified amount can then be applied solely to the house. If you don’t already own land and you’re looking for a good piece of undeveloped property, the following are the kinds of questions a realtor would ask you to determine what you’re looking for. These are questions you should answer regardless of whether you actually have a realtor:
Where do you want the lot to be located?
What school district do you want to live in?
How long a commute to work do you want?
How much acreage and how many square feet of house do you need?
What kind of view do you want?
Do you want to live in a gated community?
Do you want flat terrain?
Have you chosen a builder? Does he include the land in his transaction, or will it be separate?
If the land is separate, how much do you have to spend on the land and how much will go toward building your new home?
After you have answered all these questions and determined the type, location, and amount you want to spend on the land, you can then begin looking for your property.
Assume you have been prequalified, found your realtor (if applicable), and found and purchased your land. Now you’re ready to discuss building your new home. When you meet with your builder, all he wants to know is how much you have to spend on your new home.
His question might sound like the old car-salesperson conversation: You ask, "How much will this car cost me each month?" and he replies, "How much can you afford?"
How the Builder Goes from "Dollars on the Dirt" to Your New Home
The amount you have to spend is the most important answer you can give the builder during your conversation because it tells him how many "dollars on the dirt" you have. Here’s how it works:
The builder usually asks a follow-up question, such as what kind of kitchen countertops you’re looking for: Formica, Corian, solid surface, tile, or granite. The answer to this question tells the builder what your tastes are. For example, if you tell him the countertops have to be granite, he knows the bathroom needs to be tile, the lighting and plumbing fixtures need to be upgraded, and more floor tile than carpet is needed. If you answer that Formica is fine, he knows that cultured marble, standard lighting and plumbing fixtures, and carpet throughout are probably fine.
This single answer indicates to your builder a narrow price range per square foot he can build your new home for while meeting your expectations. Standard selects, such as Formica or solid surface, might bring the construction cost down to $80 to $90 per square foot, but the granite answer might raise the construction cost to $150 to $160 per square foot or more. Of course, there’s more to figuring the price per square foot than that, but knowing the type of countertops you prefer is a great starting point for estimating a range of construction costs for your new home.
Okay, now that the builder knows how much you have to spend and your taste in kitchen countertops, he looks at your lot size and then says, "Your new home will have a southern exposure and a three-car garage with metal garage doors. The exterior will be stucco with architectural features and a tile roof. The home will be a two-story, 2,800-square-foot Mission style, with solid surface countertops, tile floors in the kitchen and bath, carpet throughout the rest of the home, and mid-range lighting and plumbing fixtures. You’ll have 2x6-foot exterior wall construction, with R-19 blown-in foam insulation, an R-32 ceiling, oak cabinetry and stair rails, double-hung and double-pane insulated windows, two fireplaces, and a designer front door." Then you say "What? How’d you do that?"
The builder knows what most people are looking for in their new homes. He knows what he can include in his cost of construction, such as carpet, lighting, plumbing, fireplaces, and front door. He knows how much you have to spend, so he simply divides that number by his cost per square foot and then knows the maximum number of square feet he can build. He can see by the shape and size of your lot that to get that number of square feet, you have to go up to a second story. He can get all this information from learning how much you have to spend and what kind of countertops you like.
At this point, most of your questions and design elements have been established, at least to begin with. From here, everything is an upgrade or an add-on. It all gets down to dollars on the dirt.
So now you need to determine your own dollars on your dirt. Before you begin this process, however, you need to go through a few steps, discussed in the following sections.
Finding a Lender
The first step is to find a lender. Lenders can come in many forms. You might want to go back to the lender for the house you’re living in now. If you don’t have a current lender, you might want to go to the bank where you have your checking account and credit cards.
If neither situation applies, you need to find a lender yourself, which can be a bank, a credit union, or a mortgage broker. All are good choices, but you need to speak with a few and find out the details. Here’s where it gets complicated.
Choosing the Right Loan Package
I don’t have the space in this book to discuss all the possible types of loans. There are VA loans; Fannie Mae; reverse mortgages for seniors; Housing and Urban Development’s (HUD’s) home equity conversion mortgage (HECM); 15-, 20-, and 30-year fixed rate; adjustable rate mortgage (ARM); interest first; no principal (also called interest only); balloon payment; employer assisted; energy efficient; pledge assist; and more. Don’t get scared. When you sit down with your lender of choice, he asks you a few questions, much as the builder does, and narrows down your choices to one or two possibilities that are right for you.
At this point, you need to understand what lenders are offering, take notes, and then shop around for the best deal. There are a lot of variables, so comparing apples to apples is important. If you already have a trusted lender, usually he presents the best deal he has available to keep you as his customer. Even though it’s the best deal that lender has, however, it might not be the best deal you can find. Check around. Look on the Internet to learn more about mortgage types and rates. Websites such as PickMyMortgage (http://www.pickmymortgage.com) can help you go through the steps of understanding the process.
When you have chosen a lender and a type of loan that’s right for you, you know approximately how many dollars on the dirt you have and what your expected monthly payment will be. Keep in mind these figures are estimates and don’t include taxes, insurance, and homeowner’s association (HOA) fees. The accurate amount can’t be calculated until you do the following:
Determine the actual amount of yearly taxes, insurances, and HOA fees.
Lock in an interest rate.
Determine your down payment.
Estimate the remaining equity in your current home after the sale, closing costs, and realtor fees.
The lender evaluates your credit report, income-to-debt ratio, and payment history.
Again, gathering this information seems like a lot to do, but professionals calculate it one step at a time.
It seems complicated, but when you and your lender/realtor/homebuilder put a pen to paper and add up the figures, you can quickly determine how much is left over for the house portion of your project.
To get prequalified, first you’re asked to fill out a loan app (application). The lender helps you with this document and makes it as painless as possible. He or she asks you a lot of questions about your financial background and current financial condition and asks you to sign a release allowing the lender to run a credit report. (See "Running Your Own Credit Report" later in this chapter for more information.)
To do list
Record the account numbers for all your credit cards.
Record the numbers for all your checking, saving, and credit union accounts.
Gather information on your address and work history.
Gather up your last two federal income tax statements, your last two paycheck stubs, and the other documents listed in the last part of this section.