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Building Your Dream Home? Prepare Your Financing Now

July 3, 2007

By: Jim Oosterman
Melrose Bank

For most people, buying a home is the biggest decision and largest purchase they will make in their lifetime, with payments lasting up to 30 years. If you are building your own home, there are even more decisions to make. While building your own home can be an exciting and rewarding process, it can also be stressful and confusing. Choosing what you want, and knowing your financial options are the first steps to take. Knowing how to save and finance for this time in your life can make things much easier.

Knowing what you want…
It is important to know what size and style home is realistic and affordable within your budget. There are commonly two types of construction available. One is production or modular construction, which is usually offered with a handful of standard designs to choose from. For an additional cost, some adjustments can usually be made. The other type is custom home construction, where the home is designed and built based on the owner’s specifications. While modular homes are usually more affordable, with custom construction many homeowners feel they are getting more of what they really want. Regardless of the route taken, how to finance this home will be an important consideration.

...and what you can afford.
It is important to calculate your gross monthly income, expenses, and long-term debt before shopping for your new home. You will also need to have this information on hand when you go to the bank to get pre-approved for your loan. Your gross monthly income includes monthly wages, investments/dividends, and any other income. Your expenses include regular monthly bills such as car payments, credit card payments, daycare, alimony/child support, and student loan payments. Under most circumstances your monthly mortgage payment should not exceed 33 percent of your gross monthly income, and your total monthly payments on long-term debt (all revolving debt and any installment debt that will not be paid off in 10 months or less including your mortgage) should not exceed 38 percent of your gross monthly income. However, many lenders are flexible with these guidelines. Also, consider your housing expenses during the construction period. Will you be maintaining your current residence while taking on a new construction loan debt? Even if only for a year, this can be a considerable burden on your monthly budget.

Prepare Yourself.
There are several steps you can take in the months before you begin building to ensure that you will get the best deal possible on your construction loan. It is wise to develop a cash reserve account to cover potential cost overruns or unplanned upgrades and changes. Many existing homeowners who do not have a large savings account will open a home equity line of credit on their current home to cover these expenses. Paying all your bills on time is important as well. Credit scoring systems look at the performance of similar loans first when deciding what numerical score to assign. In this case, mortgage loans would have the most weight and be looked at first, so you want to make sure these payments are made on time. Determine what kind of mortgage will fit your spending and lifestyle: Fixed or Adjustable Rate Mortgage? Fixed rates continue near historic low levels and offer stability, but very low rates on adjustable rate mortgage programs may allow you to qualify for a significantly larger loan and may greatly improve your monthly cash flow.

Mortgages and Construction Loans
Building your own home is a little more complicated than simply buying an existing home. Many lenders now offer a short-term construction loan that automatically converts into a permanent mortgage when construction is complete. This saves a step and allows the buyer to avoid additional closing costs and re-qualifying for the permanent loan. The first part of the process is the construction line of credit. This is the money used to pay the contractors and suppliers during the building process. The lender provides a schedule for disbursements, usually with a term of 6-12 months. Be certain your builder’s expectations for payments during construction are similar to the lender’s predetermined payment schedule. The loan payments during construction are “interest only” based upon the amount of money actually borrowed during the project. Once construction is completed, the line of credit is paid off with the permanent loan without a second closing. The remaining term of the loan is equal to the original term of the loan minus the number of construction months.

Whether you are buying a new or existing home, custom building or awaiting delivery of a modular home, working early and closely with your lender will alleviate some of the stress and ensure that the process goes as smoothly as possible.

James Oosterman is the Vice President of Melrose Bank. He can be reached by telephone 781-665-2500, online at or on Facebook at


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