To nail down your own budget and get an accurate estimate for your project, you must first establish several variables. You need to know your financing options, find out how much financing is available, understand what this amount buys, then go to the drawing board with a good design team and solicit bids from qualified contractors.
There are 2 types of construction loans: construction only, or construction-to-permanent.
A construction only loan will only last during construction, and you must apply for a mortgage to pay it off once you move into your new home. Choosing this option typically reduces your down payment. On the downside, going with this loan type means finding your own mortgage once the loan matures, and paying for two closings and two sets of fees. You also won’t be able to lock in a favorable rate, as standalone construction loans come with variable rates that follow the Federal Reserve’s prime rate.
A construction-to-permanent loan becomes a mortgage once your home is built. Most lenders will give you the option of locking in your rates before construction starts, and you’ll only pay the interest for its duration. Once you move in and the loan converts into a 15 to 30-year mortgage, you will start paying off the interest and principal.
Opting for a construction-to-permanent loan gives you peace of mind with interest rates, post-construction borrowing, and extra fees. A drawback of this loan format is the higher down payment requirement, as most lenders will ask for 20-25%.
When you choose your construction loan type, call some lenders and figure out what your minimum down payment will be. From here, you can get a rough idea of how much financing is available for your project. For example, if you can pay $75,000 out of pocket on an 80% Loan-to-Cost loan, you can expect to borrow $300,000.
Step 3 - See how far your budget goes
Now that you know how much you can spend on your project, start planning the key elements of the building - floor area, design features, and quality of materials. You won’t have an accurate estimate of costs until you solicit bids from contractors, but average costs per square foot can help you work out an order-of-magnitude budget.
Costs per square foot depend on many variables. Custom design features, material quality, location, labor availability, inflation, and the economic climate can all cause these rates to fluctuate. Based on 2019 averages, lower-end and standard homes cost $70 and $155/ft2; respectively, while custom, luxury homes may set you back $500/ft2; or more.
Step 4 - Start the design process
Once you know what you can afford, it’s time to hire a design team and start planning your home. Your input should include the desired floor area, material quality, and design features.
These three variables have an inverse correlation. The more you spend on materials and features such as vaulted ceilings, floor-to-ceiling windows, or long staircases, the less floor area you can get without breaking the bank.
To get competitive pricing from quality builders, pre-qualify several local ones and ask at least 3 of them to bid on your project. Meet with them to spell out your needs - bidders typically sharpen their pencils when pricing clear, detailed designs.
Once you have the bids, analyze them item by item to make sure that nothing’s been omitted or added without your knowledge. This is also your chance to confirm that the bidders priced what you’ve specified, and not a cheaper alternative.
Make sure there are allowances in each bid for features that don’t yet have an accurate price tag. These include finishes you may want to choose later or items that can only be priced once construction starts.
To reduce surprise expenses caused by unforeseen conditions, add a contingency to your estimate. Contingencies cover costs that may sneak up during construction and typically comprise 10% of the total budget. Note that contractors may view a contingency as extra spending money rather than a rainy day reserve, and it may be best to keep the number to yourself.
Step 6 - Include the soft costs
Costs unrelated to construction may be easy to miss. Most are excluded from contractors’ bids. Often, no one tells you about them until it’s too late, and then they snowball. Plan for these expenses to avoid any surprises as your project gets underway:
- Contractor’s overhead and fees, excluded from the bid
- Design fees
- Permit, impact and inspection fees
- Liability insurance premiums
- Financing costs - the interest rate on the construction loan
- Utility connection costs
Step 7 - Find efficiencies
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*Note: The content published above was made in collaboration with members of Design Everest.
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