Wednesday, January 7, 2009

Paying for Your Addition - Options

Of course, the most ideal and fiscally responsible thing to do when adding to your house is to have cash or liquid assets on hand to be able to pay for your addition. Today, this is a rare occurrence and most people do not have this type of cash on hand. If you are lucky enough to have significant equity in your house, you may be able to take that equity out and use it to add to your house. Finally, if you don't have enough equity but will have at least 20% equity when you're done (based on the final product's appraisal), you may be able to get a construction loan. Different lenders offer different types of construction loans. Some allow you to pay interest only during construction, some allow you to only pay on what money you have used so far during construction, some allow you to (or require you to) lock in your final rate at the beginning. The general premise is that you are borrowing money based on the future value of your finished home. So, you can roll in your existing mortgage with your new loan and have one loan (or a combination of loans) when you are done.

If you are already heavily into planning your addition, hopefully you have already researched some financing options. A good first step is to talk to your financial advisor and see if he/she has any ideas for how to finance your house. We then spoke to several banks, both local and national, about their products. We have been Wells Fargo customers for years but their construction loan program was really substandard and didn't even really make sense. Many large banks have become particularly wary of construction loans because of their relatively high default rate. Don't think for a minute that customer loyalty is going to mean anything to one of these large banks - it really doesn't, especially during a credit crunch.

We found the best products with the most competitive rates were offered through smaller local mortgage companies and were generally found through mortgage brokers. We found a small local mortgage lender who had a product which seems like it will work for us. One thing to be wary of is what your final product will look like. Many large banks lock you into your final loan (which rolls together your existing mortgage and the money you used for your addition). You can always refinance when you're done but ideally, when you start, you want to know that you have something that you can live with at the end.

My husband called about 5 mortgage brokers with varying degrees of success. We did learn a lot from these phone calls so they were worth it. We ultimately found our lender through a recommendation from a friend.

Also, do not underestimate how long this process will take. We should probably have started working our loan in October but we waited until mid-November. Our closing is now next week (second week of January). We only found our lender in mid-December so plan for 4-6 weeks at least. Then you will get your first check (or "draw") a few days later. You also need to have your building permit in hand to get your first check.

You should work on a draw schedule with your builder when you sign your contract. Our builder is flexible on the draw schedule so he is fine with us condensing the payments so that we can have fewer draws (and pay fewer fees to the lender - about $150 per draw for inspection and processing). I'm sure I'll have a lot more to say about draws as the process moves along.

So, keep your fingers crossed that our permits and our closing both come through next week...

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