Katie DeBlasis gets a special feeling as she drives down the street to her home.
"When I pull into my driveway at the end of the day, I say to myself that's one handsome house, there's no other like it," DeBlasis said of her custom-built home in Howard County.
Her home isn't one of the cookie-cutter builder varieties. Rather, it is a custom-built.
An adage in real estate is that Americans buy the house they hate the least, but there is an alternative. About 10 percent to 15 percent of homebuyers today decide to build a home from scratch, which means construction financing must be arranged.
One of the most common methods is applying for a construction-permanent loan where the lending institution makes an initial loan that is solely used to pay for construction of the house. The money is disbursed to the homeowner's builder when specific stages of construction are reached.
After the house is built, the construction loan is converted into a permanent mortgage usually on the same terms as a 30-year, fixed-rate conventional mortgage.
During construction, the owner is required to pay only the interest on the loan. In some cases, the interest rate for construction loans can be higher than for mortgages. A survey of one institution's rates recently showed an 8 percent rate with 1.125 points for a nine-month construction loan, compared with 7.75 percent and no points for a 30-year, fixed-mortgage. Depending on the lender, the interest rate on the construction loan can be fixed or it can fluctuate.
But first things first.
Before finding a lender, the prospective buyer must learn what the house will cost to build. One of the first steps is deciding on a design, which for most people means searching though house plan magazines, visiting model homes and making lists of desired features.
"We visited a lot of model homes, but there was always one or two things we didn't like," said Brian Ahearne, who has just started construction on his new home in the Green Spring Valley section of Baltimore County.
DeBlasis recalled, "There were special things we wanted, like a laundry chute and a separate garden room for my husband's plants."
Put down on paper
The design has to be put down on paper for a builder to price the construction. This is key because the lender also will require a set of construction drawings and specifications on which an appraisal will be made to confirm the value of the project.
An owner can contact a builder who may have a draftsman or do as DeBlasis and Ahearne did, work with an architect to prepare the drawings.
After doing the research, DeBlasis and her husband sat down with Jeff Henneman of Henneman & Barton Architects in Columbia to work out the design. "After five incarnations, we had our house," DeBlasis said.
"Using an architect is well worth it," advised Larry Williams, executive vice president of Harbor Federal Savings Bank. Many architects are associated with builders and their fees usually range from 3 percent to 5 percent of the construction cost.
"Clients should come in with a realistic view of what they need and can afford," said Henneman. "But if you're going to go through with this exercise, you should end up with a design that makes the house special, [and] not wind up with an ordinary builder's house."
When the plans are completed, the owner can give the drawings to a builder they already have an association with, as Ahearne did with Regional Homes. Or the owner can put the project up for bids to a variety of builders. In the eyes of the lender, the latter course is preferable.
When the price comes in, it's usually many times higher than the owner expected, so it's literally back to the drawing board to scale down the house. The successful contractor -- or architect -- will work with the owner to bring the house under budget.
The owner can often be pre-approved for a loan amount by a lender and knows exactly what price he must work with. Once the changes are made on the drawings, the set is ready to go to the lender, along with a signed contract with the builder.
"The lender will then appraise the value of the proposed improvements and the property on which the house will be built," said Tom Champion, sales manager of Norwest Mortgage in Lutherville.
The appraiser also looks at the value of homes in the area to determine whether the project is comparable in cost and quality.
Besides the drawings, the lot is the other major factor in obtaining financing.
"Most customers have already purchased the land or have identified a lot they want when they come in for financing," said Kevin J. Michno, senior vice president in charge of residential lending with Mercantile Mortgage Corp.
In some cases they've already obtained separate financing for the lot or they include the lot purchase in the construction-permanent loan, he added. Some customers own a parcel free and clear.
No balance
If the appraisal confirms the value of the lot and proposed construction and the customer's and builder's creditworthiness is established, then a settlement date to close on the construction/permanent loan is set. A building permit is often required to be in place for the loan approval.
The closing is unlike one for a conventional mortgage. If there is an outstanding balance on the land, then a check is issued to pay off the debt.
"We don't want to be in a subordinate position to the lot loan," Michno said. "We want to be the primary lien holder."
The loan-to-value ratio of the construction-permanent loan is usually between 80 percent and 90 percent; therefore, a $500,000 project, including land, means a loan amount of $400,000 to $450,000.
A time limit of either six, nine or 12 months to complete construction is agreed upon. A check for the entire loan amount is not handed over to the customer, but deposited in an escrow account to be released to the builder according to a draw schedule.
The draw schedule, which is agreed upon by the lender and the builder, is to ensure that the work has been completed by the builder. This protects both the owner's and lender's interests, and also makes sure the builder is paid in a timely manner.
When notified by the builder, the lender's inspector will come to the construction site to verify that the work has been done. The next day, a check is released either in the builder's name or jointly with the owner who must co-endorse the check.
The draw schedule is usually done in five to seven stages where a percentage of the loan is released when certain construction milestones are met.
According to Champion, Norwest's draw is typical:
Draw No. 1: 20 percent (site excavated, foundation installed, first-floor joists installed, rough lumber stored on site).
Draw No. 2: 15 percent (rough framing complete, rafters installed, exterior sheathing and insulation installed).
Draw No. 3: 20 percent (roof complete, rough-in of heating and air conditioning, electrical and plumbing complete).
Draw No. 4: 10 percent (drywall, windows, garage door, brick work complete, exterior wood primed).
Draw No. 5: 10 percent (doors hung, cabinets, counter tops, electrical and plumbing fixtures installed, floor coverings installed, painting completed).
Draw No. 6: 15 percent (all construction except punch list items completed, notice of completion to bank and building inspector).
Draw No. 7: 10 percent (building inspector's issuance of certificate of occupancy, punch list items resolved, waiver of subcontractor liens).
According to the state attorney general's office, custom homebuilders are now required to give buyers a report within 30 days after each draw that lists subcontractors who have provided more than $500 of goods or services and to indicate whether they have been paid by the builder.
Then, when the house is within 30 days of completion or at a specified construction stage, the lender will lock the customer into a permanent fixed-loan rate, usually lower than the construction interest rate they've been paying.
Some smaller lenders, such as Harbor Federal Savings Bank where 70 percent of its business is in construction/permanent loans, charge the same rate for construction interest as they do for the permanent loan.
"If the prime is 7.5 percent, then it's 7.5 percent all the way," said Williams, Harbor Federal's executive vice president.
Deed modification
The owner will sign a modification agreement to the deed of trust that reflects the new interest rate on the permanent loan as well as an allonge -- a legal paper that says the borrower agrees to repay the loan.
If there is any money left from the construction, it is used to pay down the loan amount.
If the construction goes past the agreed-upon time limit, then an extension can be considered. "We look at an extension on a case-by-case basis," Michno said.
As the house is being built, changes are inevitable. Granite counter tops all of a sudden look a lot better than the Formica ones that were specified. "Once you've closed for that loan amount, you're closed," Williams said. "You can't renegotiate the loan." If an owner wants to upgrade some aspect of the home, it usually comes out of the owner's pocket and is paid directly to the builder.
Once the construction perm is closed, the relationship between owner and builder begins. "We don't define that relationship," Champion said. "The trust factor is between them. Lenders do not want to act as referees in disputes."
Most lenders say the builders they deal with are reputable and honest, but stress the importance of checking references and looking at the builder's previous work.
"The biggest mistake is that people think that building a house is the same as buying a house," Champion said. "The best results I've seen are the owners who take their time and look at every detail down to the door knobs in the house."
DeBlasis agrees. "You have to run out there to the site a lot and stay on top of all the details. It's not for someone who doesn't have a lot of time."
Friction between owner and builder is an accepted part of the experience. The key is not to let it explode into full-scale war. "My advice is to be as nice to the contractor for as long as you can," DeBlasis said.
One strategy to ensure that the buyer is satisfied with every detail to refrain from releasing the final draw of the loan to the builder. If that happens, the contractor and buyer usually negotiate to solve the outstanding issues.
Williams said the biggest mistake people make when building a home is acting as their own general contractor, the person who oversees the project for the buyer and who hires subcontractors.
"They say they have relatives who can do their plumbing or electrical, but they never show up," Williams said. "So, the construction drags on for months and the cost savings are eaten up by the extra interest they have to pay." Williams' bank does not allow a customer to act as his own general contractor unless he is a builder by trade.
Finding financing
Some builders offer their own financing, usually when they already own the land in the subdivision, but most would rather have customers find their own financing. Most builders will not convert the construction loan into a permanent mortgage.
A builder can also direct a customer to a bank with whom they have had a long business relationship. If an owner opts for builder-provided financing, he must do a thorough check of the builder's credit and ask to examine his financial statements.
The construction-perm has become a common method of financing one's dream house. People who have gone through the ordeal say the financing part was easy, it was the construction that was hell.
"It was stressful, but I got exactly what I wanted," DeBlasis said.
Said Ahearne: "I wouldn't want it any other way."
Construction loan
When considering a construction/permanent loan:
Carefully select a lot to build on. Consult with an architect or civil engineer about any restrictions on the lot.
Prepare a set of drawings by researching the kinds of homes you like and develop a program that describes the number, size and orientation of rooms as well as the style of the house. Consult with an architect.
Put the drawings out to bid. Select a builder by getting references from previous clients and visiting his completed work, not just on the basis of a low bid.
Work everything out on paper -- first. It's cheaper than changing things once construction begins.
Pay attention to the smallest details.
Get a signed contract from the builder and submit it along with the drawings to the lender you've chosen.
Once construction begins, make a point to visit the site at least once a week and stay on top of every phase of the construction.