The Money and The Box™
Mortgage adviser John Schumacher of Loan Market in Kingsland shares his insights into what to think about when applying for, and signing up to, a home loan on a design-and-build project.
- No surprises
The quality of the company you are dealing with is vitally important to the bank. Are they reputable, not a fly-by-nighter? Banks like to know there will be few delays with a house build and, unless you have a very strong financial position, will be keen to see a fixed-price contract. They will look closely at whether everything has been priced into the contract to see there are minimal exclusions or provisional cost sums. [Generally, at Box™, the only provisional cost sums relate to earthworks. Box ™ also includes some prime cost sums in their contract. See below *]
- Worst case first
If you already own a property, the bank will take security over that home as well as the new build. And they will be reasonably conservative on the sale price of your existing house (they’ll key the address into their online e-valuer and look at the worst-case scenario ie: the lowest sale price). When looking at how you will be able to service a loan, they generally factor in an extra 15%. For example, say you need to borrow $100K, they will look at your ability to service $115K.
- Mind the gap
Financing a new build comes with a lag: the gap between when you sign up to build and how long it takes to construct the home and move in. That can be 12 months or more. A lot can happen in that year. That’s why the banks put several scenarios on the table. As part of their commitment to being responsible lenders, they consider what would happen in a falling property market, or if mortgage rates rise, or Covid-19 shuts down the build. If you were financing a new build with a view to selling an existing property, they might ask for a rental appraisal as a Plan B back-up. My advice to clients is not only to think about how all these scenarios will look to the bank, but how they would feel to you.
- Drip-feed the beast
Typically, a new-build loan is not drawn down in one lump sum. It is drawn incrementally from invoices that match the contract; this is known as schedular payments. Depending on your situation, the bank may need progress evaluations of the job to approve these. Box™ operates on a month-by-month charge basis, invoiced to reflect the stage of the work completed so some months the cost will be higher than others. One thing to understand is that you will be paying the floating interest rate on this money (currently around 4.5% before any negotiated discounts). This type of loan cannot be fixed until the build is complete and the loan fully drawn.
To keep cashflow secure, this loan (and others), should be carefully structured. While you are waiting to move into a new build, consider putting any existing loans on interest-only repayments. Once you move in, everything can be restructured.
- This is your life
Building can be stressful so, before you launch in, think of all the financial angles. Don’t rush. I’ve had clients who have bought land only to realise they can’t afford to borrow the full amount needed to complete and then their dreams are dashed or delayed.
Check also that the land is fully serviced with power and water connections. Banks can lend up to 80% of the value in this case but no more than 50% if it’s not.
Start with an end in mind and work back with regards to total pricing. Will there be any potential surprises that may arise due to location, access or slope etc. which may add $000s to the overall cost?
Review your personal insurances. Life is uncertain. Adding life, trauma and income-protection cover at the start of the process can enable the project to finish if disaster strikes in the middle. Banks don’t insist on this, but it makes sense. Repaying a loan relies on income and on health. If either fails, you’re vulnerable. Getting all your financial ducklings in a row allows you to own the build process, not the other way around.
* Siteworks are estimated in detail but remain a provisional cost that are changed out as soon as an actual cost is known. Box™ also operates a ‘prime cost’ facility within their contracts. This is for items that are subject to change, for example an appliance that updates to a new model number before it is ordered for the project, or a tile that clients have chosen but is no longer available – so a substitution must be made. Normally, if these items were fixed price, clients would incur a 15% variation to contract fee plus a time charge for a quantity surveyor. By operating with prime cost sums there is no fee for variations. At Box™, we find this the most effective way of dealing with items where the choices are better made later in the process, for example: electrical fittings; plumbing fittings; kitchen; vanities; appliances; wardrobes; laundry; cabinetry; tiles.