Construction finance is a completely different ball game. As such it has all of its own pitfalls – it is without doubt the least understood area of mortgage financing. An area where accurate information and an expert on your team are absolute essentials to making good decisions.
Nobody likes to pay a non-refundable deposit to a builder only to find you can’t get the finance.
My very first “retail” presence in the mortgage industry was operating out of a display home that I owned and leased back to the builder. Every weekend for those two years were spent focusing on finance for construction.
So on that note, let me set the scene and open my CONSTRUCTION blog series with an important building block...
VALUATIONS
A bank lends against the value of the asset. The valuer (assigned by the bank as it is THEIR valuation – not yours) is asked to tell the bank a value that could be reasonably attained within a three month selling period. Its harsh – BUT – a bank is always looking at what it could sell your house for reasonably quickly if you default.
This value can take one of two forms
- Current Market Value
- On Completion Market Value (sometimes called a TOC valuation – Temporary On Completion)
There is another very important value for you – it’s called Contract Value.
They are not the same...
Lets say your house is worth $400k and you wish to spend $50k in renovations on it. Will its value be $450k?
The obvious answer is – it depends on what you spent the money on and whether you got “value for money” If that $50k was for a new family room and included the spend on TVs and furniture then the clear answer is obviously not. If some of that $50k included removal of an existing room then it all becomes a “matter of opinion”.
So the same principle is true with construction valuation – it’s a matter of opinion. That opinion is based on what your house will be worth in the context of similar houses in the surrounding suburb.
This is such self-evident common sense. BUT, unfortunately, common sense often disappears when emotion and money mix.
Let’s say you agree (because that what a signed contract is) to pay a builder $250k plus $50k in "extras" to build a house on land you recently purchased also for $250k.
Is that house worth $550k? Is that $50k in "extras" actually all “added value”?
Here is a FACT – the valuer will give an opinion and the bank will lend against that opinion. You will pay the builder what you agreed.
If the Bank Valuer's opinion is $550k – all parties are smiling – bank, builder and you.
But what if the Bank Valuer's opinion is $525k? This is called a valuation shortfall.
This is THE SINGLE MOST IMPORTANT FACT in construction and leads to the most tears and heartache in EVERY form of construction.
YOU MUST PAY THAT SHORTFALL OUT OF YOUR OWN CASH RESERVES BEFORE CONSTRUCTION COMMENCES!!
If you don’t have those cash reserves – harsh but true – the project will NOT commence. Your deposits to the builder are potentially forfeited and you are stuck with a lovely set of plans, but no house. (This is unless it is “off plan” where this same issue arises, only later in the process – I will be covering that issue in an upcoming blog).
Lesson – Don’t commence a building project unless you have a reasonable cash reserve.
A 'reasonable' cash reserve is individual to each situation however, with the aid of an expert it is possible to estimate what it is you will need to get your house off the plans and into reality! This is done with what is called a “Build Pack” – a set of documents that is given to me so that I can obtain a TOC valuation.
In order to obtain your Unconditional Finance Approval I will need;
- Land contract (for new) or Council rates notice (for existing)
- Fixed Price Build Contract (plus Variations*)
- Building Schedule (your selections and finishes)
- Building Specifications (shows it meets building standards)
- Contract Plans (signed and dated)
- Engineers Report (sometimes this is supplied , sometimes not)
In order to get the bank to release funds by way of Progress Payments to the builder I will also need;
- Council approval
- Builders Insurance specific to your site
Variations are an important pause point – you can make variations to the contract at any time – it’s your house – BUT – if you want the bank to lend for them I must have these with the build pack.
Any variations that come later (and there are almost always variations) MUST be paid for from your own cash reserves.
Once a house is under construction we cannot go back to the bank and ask for a new valuation – it just doesn’t happen. If you have ever driven past a site half finished – then this construction has gone horribly wrong. The bank is no longer lending and a new bank won’t pick it up. It can really only be sold for land value – after demolition!
Don’t EVER end up there!
All sounds difficult? It is to a certain extent - Construction should be entered into with your "eyes open" not your pockets. Following key advice from myself as your mortgage broker and making smart, informed desicions together however, can make your construction concepts a living reality.
Watching your HOME grow from paper plans to a physical property, and then moving in to "live your dreams" is the very reason why I thoroughly enjoy construction finance and as your trusted expert we will walk that path together.
Alan Heath
No question is too small for my time...Call or email me anytime...
0411 601 459 alan.heath@mortgagechoice.com.au