“Oh yeah? How do we pay for it?”
It’s often asked first when homeowners want to remodel the place, or at least update it a bit. Sometimes it’s asked after a builder puts together a plan and gives an estimate. The question is of utmost importance, with a less-than-simple answer.
But that answer will come from a lender, not just from looking at the checkbook or household budget. Or from the builder.
There are no easy answers or guidelines when the dream is to greatly enhance the home with a major overhaul.
Builders are not in the financing business, but they hear plenty about it.
“Sometimes we’re the first call (homeowners) make,” says Monica Miller, sales manager and designer at J.S. Brown & Co. “Some have done tons of homework and have approached a lender or have a loan.”
Generally, when talking with a client, her company outlines what price range a project might be in and discusses whether the extent of the work is justified financially for the neighborhood. Owners need to consider what they’re willing to borrow without knowing whether they can get a loan. Miller’s role might be to tell an owner about some places to inquire, but that’s when the banks take over.
“A lot of applicants come in with construction contract in hand,” says David Abood, vice president for commercial and residential loans at the Arlington Bank. “We’re not always the first stop.”
Builders do provide estimates, and they’re pretty accurate, Abood says. Built into estimates is the uncertainty of unexpected problems in older home remodeling projects. Typically, builders base estimates on a square foot cost that takes overruns into account, he says.
He often will have customers complete an informal application that includes all the pertinent financial information without documentation. He wants to make sure the goal is “in the financial ballpark” before charging the client $350 for an appraisal and doing the more complex formal application, Abood says.
The appraisal will estimate the final value of the project based on the worth of the home before and after work is done. The bank looks at what it calls “loan to values parameters.”
An owner can add to the pot if the approved loan amount would not cover the work. That is to say, owners can, for example, up their personal ante if approved for a $110,000 loan on a $120,000 project.
At times, Abood says, “We could go so far as to suggest, ‘sell your house and go find what you want’” if there’s a great disparity. But some love their neighborhoods and want to stay there at any cost, he adds.
Essentially, loans for construction are second mortgages, whether or not they’re called such. Lines of credit are second mortgages. All loans are secured by the home.
Owners planning large projects – new kitchen, new family room and related first-floor improvements, added second-floor room, etc. – are likely to spend $150,000 or more. For that amount, most owners redo their primary mortgage to include construction expenses and get a fixed interest rate for 15 to 30 years in the 4 percent range. New federal regulations require mortgage applicants to qualify financially for interest rates as high as 5.5 percent, Abood says. This is a result of the mortgage industry meltdown a few years ago, designed to avoid variable interest loans to those who could not afford them if today’s rates go up.
A large construction loan, or second mortgage, usually carries a variable interest rate that may initially be 2-3 percent with no guarantee it won’t go up. Some owners will take one of those loans and convert it to a permanent mortgage after the project is completed.
Home equity loans, which also bear low interest, usually are for smaller projects, such as kitchens or baths. They are due in five years, Abood says, though they require interest-only payments and borrowers often “just float along.”
Arlington also offers a low-interest, one-year construction loan, Abood says, designed to pay for a project before a permanent loan is made.
Duane St. Clair is a contributing editor. Feedback welcome at gbishop@cityscenemediagroup.com.
