“The idea of self-building a dream home can be quite fascinating for many homebuyers. However, venturing into such an endeavor isn’t simple and comes with its own set of challenges. For instance, borrowing an owner builder construction loan for this purpose isn’t as easy as getting a mortgage. Many lenders tend to be reluctant and skeptical to lend owner builder construction loans. This article covers various topics related to owner builder construction loans for homebuyers and real estate investors. We discuss what owner builder construction loans are, how to qualify and get owner builder construction loans, and how they work?”
When thinking of buying or investing in a new home, every real estate investor and homebuyer has three options available. First, to buy or invest in an already built property whether new or old. Second, to make renovations to either their existing home or to a newly bought but old condition property. And third, to build a new home from scratch that they have always wished for.
For those homebuyers interested in the third option, borrowing an owner builder construction loan can be an excellent move. However, there is a lot that you should know before deciding to use owner builder construction loans. Continue reading this article to learn more about owner builder construction loans and how Attorneys Funding Group can help you decide the best options in your case.
Owner builder construction loans
What is an owner builder?
In a normal case of constructing a home or any real estate property, it would be a construction company, or a general contractor looking over the entire building process.
However, in the case of an owner builder or self-build construction, it is the owner itself acting in the role of a general contractor, or a professional home builder.
In other words, while a normal home construction project would include hiring an external professionally qualified and experienced home builder or general contractor to perform the entire task – in the case of an owner builder it is a DIY (do-it-yourself) project where the owner undertakes the responsibility to do everything.
What is an owner builder construction loan or a self-build construction loan?
An owner builder construction loan is a type of loan where the borrower plans to venture into building their home by themselves. This means the owner himself takes charge of the role of a general contractor or a professional home builder.
And while owner builder construction loans are itself a separate category of construction loans, they can either take the form of a –
- Construction-to-permanent loan, or
- Construction-only loan.
We discuss these two types of construction loans at a later point in this section.
Obtaining owner builder construction loans can be quite difficult in terms of convincing the lender to approve them. Usually, lenders are less willing, skeptical, and disapproving of allowing borrowers to act as their own general contractor or builder. And the reason for this is simple.
The entire process of building a home or constructing any type of real estate property is filled with complexities and technical difficulties that only a professionally qualified, licensed, and experienced contractor should be allowed to manage. Moreover, compliance of the local building codes and safety standards also requires someone with adequate knowledge and the ability to demonstrate their skills with great precision.
How to convince a lender that you know how to build houses and hence should be granted an owner builder construction loan?
While a detailed discussion on how to qualify for owner builder construction loans will come at a later point in this article, let us here quickly review the list of things that you will need while proving to the lender that you know how to build houses and your owner builder construction loan request should be approved.
Important things required by a borrower to prove he/she can build a home include the following –
- Having a license or permit to build houses.
- Disclosing personal financial information such as bank statements and social security number.
- Having prepaid homeowners’ insurance.
- Showing a detailed construction plan or “blue book” that mentions key details about the construction process.
- Having experience with verifiable credentials related to the construction and building of homes and residential properties.
Remember that most lenders are reluctant in approving loan requests for owner builder construction loans. But those which allow owner builder construction loans require borrowers to prove that they have the required knowledge, and ability, and are preferably working as a licensed builder by trade.
Hence, obtaining an owner builder construction loan could be easy for someone having –
- the experience in the house building and construction industry,
- managing construction and house building projects and subcontractors in the past, and
- the necessary documents such as license, permits, insurances, construction plans, etc.
Understanding construction-to-permanent loans and construction-only loans
Before moving forward, it is important to explain the two types of construction loans as mentioned earlier. These are –
- Construction-to-permanent loans, and
- Construction-only loans
1. Construction-to-permanent loans
In a construction-to-permanent loan, a borrower obtains a loan to pay off costs incurred while building a home. However, once the construction stage is over and the borrower moves into the newly built home, the loan amount borrowed converts into a traditional mortgage.
This means that the owner builder construction loan becomes a fixed-rate or adjustable-rate mortgage with a loan payback term of 15 to 30 years. The biggest advantage of a construction-to-permanent loan is that a borrower pays the closing costs only once.
2. Construction-only loans
Another type of owner builder construction loan is a construction-only loan.
In this type of owner builder construction loan, the builder borrows funds as and when necessary, which means that the funds from the approved construction loan are disbursed depending on the percentage of the project completed.
Hence, the borrowers are only supposed to make interest payments on the amount of loan received or borrowed.
Another key aspect of construction-only loans is that the borrower has two options to decide the manner of repaying a construction-only loan. He can either pay the entire loan amount at maturity (which normally happens within a year or less) or obtain a mortgage to finance the loan amount in the traditional manner.
If opting for a traditional mortgage to finance a construction-only loan, a borrower performs two separate transactions. Since each of these transactions has its own closing costs as well, a borrower will be paying more fees when compared with the closing costs of a construction-to-permanent loan.
Understanding how does owner builder construction loans work
Why do lenders hesitate in lending owner builder construction loans?
Normally, most lenders consider owner builder construction loans to be riskier than other types of construction loans and mortgages. Why lenders perceive owner builder construction loans to be risky can be explained with the help of the following key factors –
- First, construction loans are being borrowed for a purpose that is likely to happen in the future. This means asking for funds for a project that hasn’t been built yet and doesn’t exist to serve as collateral.
Because of this, owner builder construction loans carry an inherent risk of not having any physical form of guarantee. Of course, all lenders require having some form of backup to safeguard their financial interests in case the borrower defaults.
- Second, the changing housing and building material market has its own set of threats and risks that the lender will consider before approving an owner builder construction loan. For example, rising costs of building materials, supply shortages, and transportation delays, all have an impact on the construction plan and project feasibility.
How do owner builder construction loans work?
Unlike other loan and mortgage types, an owner builder construction loan, if approved, doesn’t come as a lump sum amount. Rather, funds are disbursed as and when needed. This means funds are issued depending on how the project makes progress or the percentage of work completed.
Borrowers need to understand two important things at this stage.
First, they need to know what kinds of expenditures are allowed to be funded with an owner builder construction loan. For example, spending on home design or furniture isn’t allowed out of owner builder construction loans. However, buying home appliances is considered a construction cost.
Second, borrowers should discuss with their lenders beforehand what happens if something doesn’t go as planned. For example – delays caused or some expenses going beyond the budgeted amount. The schedule provided to the lender has all relevant information about how the construction process will move forward.
Upon completion of the construction process, the entire amount of owner builder construction loan becomes due. However, this doesn’t mean that the owner builder has to settle or repay the entire loan amount at this stage. Instead, he has two options depending on whether he is buying or selling the home.
In the case of buying the newly built home, the borrower can refinance the owner builder construction loan into a traditional mortgage with a 15-to-30-year term.
Similarly, as a seller, the borrower can place the newly built home up for sale on the market in which case the homebuyer will repay the loan in the form of regular monthly payments.
How to qualify for owner builder construction loans?
As already mentioned, several times in this article, lenders are unwilling and less likely to approve owner builder construction loans. Hence, for any prospective borrower to prove that he can undertake an owner build construction project on his own will require strong effort, honest and full cooperation during background checks, and practical demonstrations rather than making mere arguments.
For instance, having a credit score between good and excellent will enhance the lender’s confidence to approve an owner builder construction loan quickly. Similarly, the borrower should also provide the lender with complete and correct information to corroborate their reliable financial position.
This includes information such as DTI (debt-to-income) ratio, having adequate cash reserves, and their ability to pay down payments. Doing this will further assure the lender that the borrower is financially sound to fulfill his/her repayment obligations against the loan borrowed.
Getting owner builder construction loans is typically harder than obtaining a mortgage. This is because it involves a lot of risk for the lender whose main concern is not having an existing collateral property to guarantee the loan amount. Hence, it is recommended to seek professional advice and evaluate the best options available in your situation.
At Attorneys Funding Group, our loan advisors and experts know exactly how to accommodate and address your need for an owner builder construction loan. We have decades of experience in helping many clients make the right decision that suits their financial position.
Call us now at (916) 471-2678 or click here to book a free consultation session and discuss your mortgage needs with one of our expert loan officers.