Should I get a home construction loan?

Thinking about getting a construction loan for a tiny house? We’re here to help you sort out the details.

Financing a new home of any size isn’t easy, given the legacy of the 2008 sub-prime lending crisis and the conservative attitude that has pervaded the banking industry ever since. These days, buyers more often than not are responsible for obtaining a loan for home construction, with the result that many of the new houses built in recent years are constructed by huge corporations with massive lines of credit. Unfortunately for the tiny house movement, anything smaller than 1000 square feet is hard to come by in the world of ticky-tacky, matchbox construction schemes.

So, let’s assume that you’re looking to take out a personal construction loan, probably from a local bank in the area where you plan to live. (My advice is to disregard the big national banks here, even if you’ve been with them for decades and have never missed a payment.) In these cases, there isn’t likely to be any collateral for a loan, since there is no finished home for the bank to take possession of in the event that you default, so special guidelines may apply. For example, the bank may insist on reviewing and approving your plans before construction can begin, a detailed budget, and they may have someone monitor progress on the home even once the plans are approved, to ensure it is finished on schedule and you can begin making payments on the loan.

In most cases, loans of this type are short-term, with a maximum term of one year. They may have variable rates rise or fall with the prime rate, and these rates can be expected to be considerably higher than standard 30-year mortgage loans.

When the loan is approved, you’ll be on a bank draft schedule. Portions of the loan will be disbursed according to the approved time-table of construction for the house. You may be expected to make interest payments during this time period. Make sure to include some wiggle room for construction delays due to bad weather, seasonal unavailability of materials, and unpredictable problems that may arise from inspection schedules, etc.

The completion of a home is marked by the issuance of a certificate of occupancy, and the full payment of contractors involved in the project. (Their signatures may be required on lien releases.) At this point, your loan will probably roll into a mortgage. Ideally, you only want to pay closing costs once. If the bank wants you to pay more than once, take them to the negotiation table, or find another bank to work with. (Regardless, you definitely want to shop around before signing a dotted line.) In many cases, banks will combine the loan and closing costs into a single 30-year loan with one closing. This is known as “construction to permanent” financing.

Be advised that lenders are unlikely to cover more than 80% of the project costs, and some will only be willing to cover much less than that. If you already own the land where the house will be built, then that can serve as equity as well and prove helpful in obtaining better terms. For that reason, I recommend purchasing a plot of land before meeting a banker, if you’re certain that you mean to follow through with the project.

All that aside, you want a personal opinion, a prospective home-owner looking to finance a tiny house is unlikely to be taken seriously by most any bank in the country. Unfortunately, our movement is often regarded as a passing phase of the naïve, unrealistic and immature. For that reason, I advise you to save funds the old fashioned way, or be especially kind to your wealthy friends and relatives. On the upside, tiny houses are a much more affordable way of meeting our needs, on the whole, so don’t feel too discourages. The advantages are all ours in a world of rising housing prices, construction costs, and mortgage interest rates. Every year, more progress is made to legitimize and legalize the tiny house movement. The day will come when the problems we face today will no longer be true for future generations. Until then, keep your eyes peeled on the tiny house blog for news, updates and lots of cool ideas related to small homes.

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