If you've ever researched the real estate market or purchased a house, you're probably familiar with the three things most important in real estate: location, location, location. Location affects the price of homes, the number of homes available, and how quickly they sell.
The same mantra of location, location, location is true when you're building a custom home on your land and applying for a construction loan.
The total amount of your construction loan hinges on the appraised value of your not-yet-built home. And that appraised value depends heavily on recent comparable sales of existing homes in the same general area. If the values of recent home sales in the area are low, the lender can't justify the cost to build a new home based on nearby property values. We've seen that happen when the nearby houses are old, small, or built with inexpensive finishes.
Real life example
One of our recent clients wanted to build a smaller home but still a very nice home. When we worked through the design process, she selected a lot of higher-end features for the home. She also wanted large covered porches and patios, which add cost to build but don't count as square footage included in the appraisal. Another feature that again costs more and doesn't get included in the appraisal was the large detached garage and shop.
All of the recent home sales in the area were older, smaller homes. They didn't sell for a high enough price to justify the investment this client needs to build the home she wants on the land she already owned.
Now, that doesn't mean she can't build her home where she wants. But it does mean more of the cost will be coming out of her pocket because she can't get approved for a construction loan to cover the full cost to build.
The lesson here?
Be sure to consider the value of nearby homes when you're deciding where to build. Comparable sales, even if they're not quite comparable in size or features, will determine how much the bank will allow for your construction loan. If you're looking for land, check out the recent sale prices of homes nearby before you decide to buy that land.
This is just one of many factors that affect financing for your custom home, so be sure to read our other financing articles so you're prepared for every possibility.