Small House Construction: Financing

Currency sign used in Brazil

Currency sign used in Brazil (Photo credit: Wikipedia)

   I’m going to talk about a topic that makes many people uncomfortable:  money.  It’s such an important piece of this endeavor that it’s surprising to me people are cryptic about it.  Sharing pics of your bathroom and the color of your bathrobe is not “personal” but how you paid to build your small house seems too personal for most to share.  I arrived at this conclusion after reading scores of small house blogs trying to answer the question “How am I going to pay for this??” 

 Since we don’t live in a socialist society, it’s obvious some have more than others. 

   English: : the mansion. Français : Drummond Ca... Tiny house

I will tell you right now that building a small house, even a tiny house, is not cheap.  Constructing a tiny house that is < 300 sq feet, even if you build it yourself, will cost at least 25K in materials, plus the cost of the land, permitting fees, excavation fees for tying in to utility lines, etc.  It’s awesome if you inherited the land or have enough equity in your current house to sell it for the entire construction price.  Or a grandparent left you a sizeable inheritance.  Or you’re the princess of Monaco.  However, most of us in our 30s haven’t lived in homes long enough to acquire that much equity, are still renting, or don’t have enough savings to pay for it all in cash.  Plus, as you can imagine a small (not tiny) house of approx 1000sq ft will be a sizable sum.   Hmmmm… 

In my mind, since I like to compartmentalize everything, the cost can be blocked off into the following sections: 

1.  land

2.  pre-construction fees (surveys, zoning, design, soil testing, engineering, permitting)

3.  foundation construction

4.  building construction

5.  post-construction (occupancy permits, landscaping, furnishings/interior decor)

So, ask yourself this:  how much do you have for each of these elements?  Whatever you don’t have, you will need to finance (=borrow).  Or you will need to take baby steps, such as purchase the land one year as an investment, begin the pre-construction process another year, then build the house next, etc.

I discovered a type of bank loan called construction financing.  Nearly all the major banks offer this, and many local banks do as well.   The structure of the loan is very much like a mortgage.  20% downpayment, low APRs, and monthly payments up to 30 yrs with interest only payments while the house is being built.  You apply for one just like you apply for a mortgage.  There a few key differences, however, which become mucho important in the end:

a)  They want to know the location and specs of your future house before they approve the loan.  That means you need to identify a lot, have a houseplan and a description of the interior finishes before you apply.  An example:  Proposed house will be a 2bedroom/1bath house located in Mysuburb, PA  with energy-star rated appliances, solar panels, nickel fixtures etc.etc.etc. … and will look like this (attach pic of floorplan and exterior elevations).

b)  Once the loan is approved, the dollar amount approved is just a placeholder.  This is the kicker:  they will appraise the post-construction fair market value of the house and loan 80% of that value.  This is the part that’s scary, and here’s why:  let’s say your entire estimated cost is $200K, and the bank approves a loan for 80% of this amount.  However, your lot in Mysuburb, PA is in a neighborhood where  2BR/1Ba homes are selling for $100K.  The appraiser looks at these “comps” (comparable sales) to appraise the final value of your home.  Even if they say, well your house is new so we’ll appraise it $50K higher than the comps, that means the appraised value is still short at $150K.  They’ll only loan you 80% of that, which is $120K.  So guess who has to pay the difference of $80K?  You! Yikes!

That is the reality of how real estate values work.  Just because a house cost $200K to build, doesn’t mean that’s how much it’s worth.  On the flip side, it could be worth a lot more if you build in the right neighborhood where comps are selling for a lot higher.  It really is about location. 

c)  The bank pays for the construction in stages, and typically directly to the other party, not you.  The bank and builder come to an agreed upon “draw schedule”.  This commonly reads as :  15% of funds to be disbursed once construction of foundation is complete, 20% once construction of exterior walls and roof is complete, etc…  If you’re financing the lot, the bank may have a separate agreement with the seller of the lot.

d)  They won’t finance the “tiny house” due to poor resale value.  If this is your plan, banks that offer financing for mobile homes may be a better option.

Here is my disclaimer in case a lawyer or banker is reading this:  the above information may be fraught with error as it is my, and only my, understanding of construction loans.  Please consult with your loan adviser before applying for a construction loan.  😉

I’ll leave with a song that I just can’t get outta my head today 🙂 


3 thoughts on “Small House Construction: Financing

  1. You did a great job outlining all the details. I wish more prospective homeowners would do their homework as well as you have. I still have a passion for homebuilding and hope to sell my current 2 year old home so I can build another. Homebuilding has become a hobby for me now instead of a business. Enjoy. I look forward to following your progress.

    • Thank you so much!! It’s great that your passion for homebuilding is still alive! I have no clue what’s ahead of me once we actually break ground. Once it’s all said and done, I hope the experience is awesome enough that I’d want to do it again 🙂 We’ll see!

      • Break it down into baby steps and don’t over think and you’ll have a good time. AND I bet you WILL want to do it again!

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