Get The Money, Then Break Ground on Custom Home
Kevin J. Daum

This article was originally published in the May 4th, 2001 edition of the East Bay Business Times.

Kevin Daum of Stratford Financial Services compiled the following list of common "misconceptions" about financing and building a custom home:

1. I have to pay off my lot before I get a construction loan.
   I should pay for everything myself first, and then get my loan.


Many borrowers expend all their savings on their land and then their plans and permits, leaving themselves cash poor. Lot financing requires small down payments because you need cash reserves to qualify and to run a home-building project Generally, once you put cash into a project, you can't get it back out until a year after it is built. Borrowers in this position often have trouble getting a loan due to poor liquidity.


2. I should get my lot, plans and builder before I start worrying about the construction financing.


Unless you are building your project completely from savings, you will rely on funds from a lender. Many consumers plan their whole project before consulting a construction lender. They invest years of time and thousands of dollars, only to discover they made vital mistakes along the way, restricting the financing of their project or stopping it altogether. A knowledgeable loan officer can engineer your financial picture over time to meet lender guidelines, ensuring qualification for the best loan programs.


3. I should buy my lot, and then decide what to build.


The lender evaluates the property for finished market value and conformity with the neighborhood. Overbuilding or under-building for a neighborhood can cost you cash and equity.


4. I can start with a small loan at the beginning and just finish out of savings, borrowing as little money as possible.


The size of your permanent loan should be determined within the context of your entire financial picture.

Between savings and the loan, you must have enough money to cover the entire cost of the project plus any overages. More than 25% projects run over budget by as much as 30%. If you run out of money, you can expect to pay high fees for additional cash, if it's available at all. Your project could fall to foreclosure.


5. Construction loans are just like any other home loan. The best loan has the cheapest rate and fee.


When you purchase or refinance a home the process is over when the loan funds. The success of your construction project will depend on how well the 6 - 12 month disbursement procedures are compatible with your finances and your builder's style. A problem in this area could cost you months, thousands of dollars, maybe even your project. The variables in qualifying for a construction loan are ten times that of purchases and refinances.


6. I have to sell my home and rent before I can start building my new home.


Many investors don't consider your existing home in qualifying for your new home. This fact, coupled with low rate cash out refinances and credit lines can mean you may only have to experience the inconvenience of moving when your Dreamhome is complete.


7. My house will be worth what it cost me to build it.


No buyer or lending institution will judge the value of the property based solely on how much money you put into your project. They will account for the money that you have contributed, but the weight of their lending decision will be made on the appraised market value.


8. The construction loan will pay for everything along the way, so I don't need to use my savings.


Almost all construction lenders have now use a "draw reimbursement system". This system reimburses you for work that you have already completed or money you have already paid. This means that you have to pay for the work before the lender will give you any funds.

About the Author...
Kevin Daum is the Founder and CEO of Stratford Financial Services, a Real Estate finance and education company, founded in 1989. Stratford specializes in Purchase loans, Refinance loans and Custom Home Construction finance and has successfully financed thousands of clients. He is the author of "Building Your Own Home for Dummies" (Wiley), as well as "What the Banks Won’t Tell You." Mr. Daum was an Underwriter for Plaza Savings and Loan and Key Bank of New York. He is an INC 500 CEO and has been listed as one the 40 Most Influential People Under 40 in the San Francisco Bay Area. He is the Global Chair for the Edison Innovation Program with the Young Entrepreneurs' Organization (YEO) and is a founding Board member of the Bay Area Chapter of YEO.

Mr. Daum is a frequent contributor to numerous business publications on the subjects of Real Estate and Small Business leadership and speaks regularly on both subjects. He can be contacted at kevin@stratfordfinancial.com.