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New Construction Home: Pay Cash vs. Construction Loan

Home Personal Finance and Budgeting New Construction Home: Pay Cash vs. Construction Loan

  • Avatar Baseballmom94 
    Participant
    Status: Spouse
    Posts: 14
    Joined: 06/13/2016

    My husband and I are in contract to build a house on a lot that we purchased with cash. We are ages 53/54 and about 6 years from retirement.

    We are considering whether to pay cash or take out a construction loan. With either scenario, the builder would be paid in 5 draws based on specific parameters of the project being met (foundation poured, framing, drywall, etc.)

    Cost of Lot: 153,000
    Cost of House: 584,000
    Total: 737,000

    Equity in current house: 400,000

    I have only talked to our current mortgage lender so far. That bank offers a construction to permanent 3/1 ARM at 4.375% plus about $4500 in closing costs. Since we have the full amount in cash at Ally Bank, we feel that it makes no sense to finance the construction loan considering the interest rate and closing fees. We can pay the full amount of 584,000 to the builder from our savings account and still have 275,000 left in an emergency fund. Then when our current house sells, we will recoup 400,000 which can be placed in CDs/Bonds.

    If we do pay cash to the builder, we are wondering what safeguards we need to protect ourselves. These are some of the items I can think of as of now? Open to any advice!

     

    1) Obtain Cost Sheet from builder? We have our contract, plans and Spec Sheet but the bank would require a “builder cost sheet” for financing so wondering if this is something we should obtain if we are providing our own financing.

    1) Hire our own inspector to inspect work prior to each draw?

    2) Do we need to worry about obtaining Lien Releases for the subcontractors?

    3) Do we need to purchase additional title insurance other than the initial title insurance when we closed on the lot?

    4) Do we need to involve a real estate lawyer? We’ve already signed the contract so I don’t know what value a lawyer would add at this point.

    5) The builder is requiring a letter from our bank stating that we have sufficient funds to satisfy the contract price. Should we ask him to provide us with any documents proving that he has sufficient capital to pay his subcontractors. The builder has a good reputation and we trust him but just wanting to make sure we protect ourselves as well.

    Any other advice from people who have paid cash for new construction?

    #197321 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 679
    Joined: 02/06/2016

    I don’t know the answer to your question, but it seems smart that you are asking this question.  During the real estate crash of 2008, our friends had a home under construction.  They lost both their money and their new home when the previously reputable builder had financial difficulties.

    The project was performed within an LLC created by the builder, so even though he had personal assets, when the LLC that was formed to build the house went bankrupt, there was no legal recourse to go after the builder.  It was a devastating financial disaster for them, and they have yet to fully recover despite living in a modest rental apartment rather than the dream home they were in the process of creating.

    If I were in your shoes, I might consider having an experienced real estate lawyer make sure that the structure of the contract offers you sufficient protection.  A contract really only becomes important when things go south on a project.

    #197334 Reply
    Liked by jfoxcpacfp
    Avatar Xeno 
    Participant
    Status: Physician
    Posts: 102
    Joined: 01/24/2016

    I briefly looked into this when I was considering doing a major renovation for cash. Our architect recommended using a third-party construction escrow service, which would hold the funds in an interest bearing account and release them to the contractor once each stage met approval by the architect and/or by municipal inspectors.

    Of course, it’s easier to let the bank be the “bad guy” when it comes to rigor of inspection, not accepting that things cost more due to verbal change orders, etc. Perhaps an approach that would enable you to get the benefits of using the bank while minimizing loan costs / forgone interest would be to get a low-closing cost / no pre-payment penalty mortgage (may need to shop with an independent mortgage broker), or to use your current bank, but only borrow 20% LTV, but still make sure that they’re holding your 60% “down payment” (in addition to your 20% LTV lot already bought with cash) in an interest-bearing escrow account and are doing the same degree of due diligence with inspections prior to each draw of mostly your money but enough of their money to keep them interested.

    #197405 Reply
    Liked by jfoxcpacfp, Zaphod
    Avatar SValleyMD 
    Participant
    Status: Physician
    Posts: 379
    Joined: 05/12/2016
    Disability Insurance

    I would say no to all 5

    There’s an inherent amount of trust that is just required with the builder so I would really do due diligence beforehand. After that it’s being A Hawkeye each day with the work that has been done. From what I understand the city building inspectors will be required to sign off on each phase. Personally not sure what else u can truly do. Others may have better ideas or opinions.

    Truthfully the greatest financial risk is yourself. Go in with the mindset that you’ll limit nearly all change orders and you’ll stick to the budget or just factor in an extra 10% or 100k because you’ll likely use it.

    #197434 Reply
    Avatar Kamban 
    Participant
    Status: Physician
    Posts: 2059
    Joined: 08/01/2016
    1) Hire our own inspector to inspect work prior to each draw?

    Click to expand…

    I did this for the initial monthly draws. Found it to be useless. He would take good photos and charge me $400/per inspection. Really did not do much other than to state that it was done. he never checked the quality of the work. Found it useless and let him go. And he was supposed to be an inspector that banks hire too so I am not sure what the banks are really inspecting for their construction loans.

    Hope yours is better, if you hire one.

    2) Do we need to worry about obtaining Lien Releases for the subcontractors?

    Click to expand…

    Yes. Make sure it there before you pay for the draws. I have now started to pay the subcontractors directly,So I have evidence I have paid them their invoice with bank statements.

    3) Do we need to purchase additional title insurance other than the initial title insurance when we closed on the lot?

    Click to expand…

    Not sure of title insurance because i have owned the land for a long time. But I did purchase insurance for the construction in case when the house is almost built it falls down/burns down. Even though the builder is supposed to carry insurance for that I don’t trust it fully and hence I got additional insurance for the whole amount. Once the house is fully constructed I will change that to full regular property insurance.

     

    #197437 Reply
    Avatar Kamban 
    Participant
    Status: Physician
    Posts: 2059
    Joined: 08/01/2016

    4) Do we need to involve a real estate lawyer? We’ve already signed the contract so I don’t know what value a lawyer would add at this point.

    Click to expand…

    I used a real estate lawyer to draw up the builder’s contract

    #197438 Reply
    Avatar ajm184 
    Participant
    Status: Other Professional
    Posts: 511
    Joined: 07/14/2017
    1) Obtain Cost Sheet from builder? We have our contract, plans and Spec Sheet but the bank would require a “builder cost sheet” for financing so wondering if this is something we should obtain if we are providing our own financing.

    Click to expand…

    Don’t know answer, but don’t think you would be provided such a sheet either way as some easy math will allow you to calculate the profit margin.

    1) Hire our own inspector to inspect work prior to each draw?

    Click to expand…

    I would consider this step.  Even the best builders/homes can have issues during the construction process.  In our area, reliance upon the city building inspectors is less than re-assuring.  Maybe your area is different.

    2) Do we need to worry about obtaining Lien Releases for the subcontractors?

    Click to expand…

    A bit if you are paying cash.  Yes, it is a huge issue if you pursue a loan.  It is also good practice in my opinion to insure there are no mechanic’s liens, shows the builder is doing the right thing by paying subs on time.

    5) The builder is requiring a letter from our bank stating that we have sufficient funds to satisfy the contract price. Should we ask him to provide us with any documents proving that he has sufficient capital to pay his subcontractors. The builder has a good reputation and we trust him but just wanting to make sure we protect ourselves as well.

    You should be able to easily obtain this from your bank.  Not sure if applicable, but the 5 draws should cover between 90% – 95% of cost of building the home, unless 5th draw isn’t paid until the home is totally complete/spotless (mean you the owners/inspectors have gone through and are satisfied with the entire punch list to be addressed).  Basically, the profit the builder would obtain is held until fully completed to owners/inspectors satisfaction.  I would also consider having monetary penalties of total payments if work relative to draws is not completed by certain dates agreed upon by you and the builder so that you are not in a position of having to find a place to stay for 3 or 4 months while your home is being finished.

    #197443 Reply

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