Calculating the Construction Loan & What You Need to Save

It seems that there’s really no good information online about how construction loans are calculated, or at least not that I’ve found. But it’s really important to figure out ahead of time for planning and saving. I’ve read that a lot of people are surprised when they apply for a construction loan due to not understanding how much is actually required for the down payment and how it’s calculated. I’ve spoken to a couple of different banks and they all pretty much are calculated the same way – it’s just that different banks will loan different Loan-To-Value (LTV) amounts.


Here’s the basics for how construction loans are calculated:

Step 1: Add up the following: current/appraised land value + builder’s contract + anything you’ve already paid for the house/land (architectural plans, site design, permits) + construction closing costs

Step 2: The bank will loan you the lesser of the two amounts: 1) the appraised value after your house is built, or 2) a percentage of the cost to build. The percentage of the cost to build (LTV) can vary based on each bank, but I’ve found that 80% LTV is average.

Step 3: Take the loan amount from Step 2 and subtract any remaining balance you may have to pay-off your lot loan. This is now the funds available to use towards your builder’s contract price.

Step 4: Take your builder’s contract price that you’ve gotten from your builder and subtract the amount from Step 3. The difference between those two is the amount that you need to bring to close the loan – your down payment.

Step 5: That’s not all that you need to save though in order to build home. You also need to save up for all of those expenses that goes into the home building process prior to breaking ground (closing costs, architect/engineering fees, site design, and permits prior to closing). Add all of those things plus the down payment calculated in Step 4 and that’s the TOTAL amount that you need to save in order to build a home.


I’m sure this is a little hard to follow, and if you’re anything like me, you’ll want to see this in excel to be able to play around with different costs/values. The attached spreadsheet does just that. This of course is based on our loan and house values. It shows the calculation I did for HomeStreet Bank. I worked with Adam Stoecker at HomeStreet Bank and he said that for our house, they would ideally not loan more than 80% of the value assumed, but they do have the ability to loan higher if needed. The attached calculation is pretty basic but does a good job at showing how much we need to save in order to build (click on the link to get the excel file).

 Example Downpayment Calculation

Example Down Payment Calculation

 

The banks also want to make sure that you have a reserve of 6 months of your future house payment liquid. They basically want to ensure that you’re not spending every last dime you have to build your home.

So, just exactly how are you supposed to save so much? Well, of course you can use your savings, and whatever profit you have from selling your current home (if any). But I was surprised to find out that one of the banks we looked into (Washington Federal) only requires that 5% of the down payment actually comes from your own funds. So, if you have some wealthy relatives, or a hefty 401k plan and would like to take a loan for the other 95%, you can do that. But if you’re like us – we’re going to fund our down payment the good ol’ fashioned way – saving!

Choosing Our Builder

We were still in awe about how much we learned about both Builder B and Builder D in our reference check process…definitely worth the time invested. And of course, based on that little exercise, we were now definitely leaning towards Builder B. One of the reasons that we weren’t initially “sold” on Builder B was because he really didn’t sell himself. You could tell that both he and his dad were genuine, and that they would build you a quality house, but they weren’t very outspoken about themselves and their work. So, although they didn’t brag about their work – their references did and that really filled in the missing piece of the puzzle for us.

After the references, we really sat down and discussed making the decision to use Builder B. We had an overwhelming reaction – of course we should use him…let’s do this. So we called Builder B and asked a few more questions (geez we have a lot). We hung up, discussed our thoughts on Builder B’s responses to our questions and called him back to ask one more question…if he wanted to be our builder! And he said “uh, yeah”! We were so happy that Builder B – Matt Ruttan from Ruttan Construction said yes and that he’ll be building our house! We really feel like he’s going to be a great builder for us, exactly the type of person that we want building our dream home.

Calling All References

 

We have now narrowed our search to two builders: Builder B and Builder D. We liked both of these companies because they’re small family-run father/son businesses in our area. Both of them have been established for 30+ years in our area, built beautiful homes, were in our price range, and we ‘clicked’ with them at our prior interviews. We met for the third time with Builder B yesterday and Builder D has been out of town for the past couple of weeks so we haven’t been able to set up another appointment with him yet. We figured that we’d take the next few days to call all of the references that the builders had given us. I ended up staying home from work today because our littlest one is home sick with a pretty rough cold. His independent play + nap time gave me the perfect amount of time to focus on calling references.

Builder B

I started out by calling Builder B’s references. He gave me a list of seven different people that their company recently built custom homes for (I called four of them), one real estate agent whom they do a lot of business with, and two subcontractors that work closely with the company. Here’s my quick notes on what the references said about Builder B.

Reference 1 (Mr. R): Mr. R met Builder B at one of the homes that Builder B previously had built that was currently up for sale in a neighboring city. Builder B and Mr. R got into a discussion about the house and how it was built – and he instantly knew that he wanted Builder B to build him and his wife their dream home. Builder B helped them find the right property, walked them through the permitting process and build their house. Mr. R said that they did an outstanding job at estimating and making sure that job was organized. He said that overall the budget was definitely estimated correctly – he had allowances for most of his items, the actual selected product pricing came in higher on some items and lower on others – but that the budget stayed balanced. He said that there were never any surprises; he was kept up to speed with what was happening with the project with weekly tours/inspections. Mr. R said that they were accommodating and very kind. It’s been a year since his house has been built and Mr. R was thrilled that they still knew who he was and that Builder B could easily answer questions about his house. Mr. R mentioned that the quality of the subconsultants hired was great – and that they kept a clean jobsite and that Builder B was onsite about 70% of the time.

Reference 2 (Ms. A): Builder B did an extensive remodel on Ms. A’s house, and she started off the conversation by saying that she couldn’t recommend anyone higher. She herself grew up in the construction industry with her dad being a contractor so she knew just what to look for when interviewing builders for her project. She said that Builder B was very responsive and it was clear that he cared immensely about the relationships that he built with his clients. Ms. A said that she instantly knew what her costs were – Builder B is completely transparent with the billing/invoicing and always gave options to choose less expensive finishes to save her money. She said that there were no surprises, that Builder B is delightful, nearly flawless and that they would chat frequently by phone if not in person. She said that he always took care of things and had a tight control/close supervision of his subs. She said that he builds things the right way, even if it took more time or was more expensive to do so. She also said that he was extremely realistic with the schedule (even though it meant not being able to have her house done by the time of her son’s graduation party). When discussing subconsultants, Ms. A mentioned that she was completely insulated from the subs – Builder B took care of all of them and not one came to her with issues about the project or working for Builder B. She said that he was firm but fair with the subs, was a very good communicator with them, and was extremely selective with who he’ll have be a subconsultant on his projects. Ms. A worked from home and loved the guys that came into work – said that she’d welcome them (and Builder B) back any time.

Reference 3 (Mr. D): Mr. D said that he would absolutely recommend Builder B to anyone looking to build a custom home. He said that he was genuine, has a good personality, was on-time, and excellent quality. Other words he used to describe Builder B was thorough, flexible, honest, a real pleasure, and a quality individual. He said that Builder B really made it feel like he’s working for you. When I asked about the subonsultants, Mr. D said that he used great subs – and wished that he had use all of the subs that Builder B normally uses. To save money, Mr. D ended up using an acquaintance to do the tiling work in his house. He said that the quality was so poor and that the tiling job really looks bad compared to the quality work that Builder B did. He said that you get what you pay for though, and that it really was a mistake to not use all of Builder B’s recommended subs. He also said that he would think that the subs Builder B uses would say that Builder B is a stickler on the details…good for the homeowner! Mr. D said that Builder B’s pricing was very accurate and that he made his subs stick to the quoted pricing. He also said that he ended up using a pretty bad architect and that Builder B had to fix some of the mistakes that the architect had in the plans. He didn’t go into a lot of detail on this, but I’m assuming that since it was worth brining up it probably meant that Builder B went above and beyond what was expected to make sure that the house was built properly.

Reference 4 (Mr. M): Mr. M is in the commercial contracting business and said that Builder B was recommended to him by a neighbor. After interviewing a few different people to build his home that he went with a gut feeling he had to choose Builder B. His home was recently completed in 2013 and said that both the quality of his house and the quality of Builder B was top notch. I asked him if there was anything that he wished he would have done differently and his answer: nothing. That’s pretty amazing right? He loves absolutely everything about his house?! That means that he had a great architect and a great builder. Mr. M said that everything went smoothly with the build. He said that Builder B was honest and upfront, didn’t nickel and dime him, and that Builder B does things the “right” way. Similar to Mr. D’s scenario, Builder B also beefed up the framing because the architect didn’t design it properly. I really like that – going above and beyond to make sure that the structure of the house is sound. Again like Mr. D, Mr. M used some of his own subs and wishes that he wouldn’t have – it saved him money but he also received a noticeable decrease in the quality of their work as compared to Builder B’s subs.

Reference 5 (Ms. J): Ms. J is the real estate agent that Builder B has been working with for many years now. She recommends a lot of her clients to use Builder B and follows their homes being built from the ground-up through the construction process. She also said that he’s going to be building a 4,000 square foot addition onto her current house in the near term and will be using Builder B for the construction. She said that they do amazing construction and that the homes she sells that were built by them typically sell for multiple offers – two of the homes she’s sold for them were record sales in the area of the homes (the highest cost per square foot when sold). She said that they have a distinct quality and craftsmanship in their houses. A few of the buzz words that I picked up on that Ms. J used to describe Builder B was: honest, trustworthy, goes above and beyond, and worry free. One of my favorites is that she said Builder B is super anal retentive about getting things done correctly and really cares about his projects. She said that he takes pride in what he does and that he has a high attention to detail. My other favorite thing she said was that both the dad and son of Builder B are good ol’ boys – doing things the right way. She said that they treat every home like it’s their own…and that the jobsites are clean! Ms. J said that he is very organized and that the subs LOVE working for him and think that he’s great. She said that he has the best subs in the industry, that they’re always paid on time, and that Builder B has high expectations of their subs. Ms. J also said that Builder B will keep you on budget and lets you know immediately how the budget changes based on your finish selections. One final thing she noted is that they have a good reputation with the County and the County’s permitting office and that the inspectors like them.

Reference 6 (Mr. A): After all of those great reviews from past clients, it was time to move on to do my due diligence and call the couple of subs that they gave me contact information for. Mr. A is actually not only a subconsultant, but also a past client of Builder B’s! He selected Builder B to build his house. He said that Builder B truly has his clients best interest, a high attention to detail, is honest, hard-working, and really values his business. It was apparent that he really enjoys working with Builder B and was extremely happy with the work that Builder B did in building his own house. He said that he is always paid on time (something that you need to watch out for) and most of the time he’s even paid early! Mr. A said that both the son and dad of Builder B are responsible for the decisions that they make and stand behind their word. He also said that they don’t tolerate a messy jobsite, make sure that people clean up, and that they’re extremely organized which makes working for them easy.

Reference 7 (Mr. J): Finally, the last one – Mr. J. Come to find out, Mr. J and Builder B have grown up together and have been family friends for quite a while. Based on that – I knew I wasn’t going to get a bad recommendation from him! This call was pretty quick, but he said that Builder B has great guys, he’s paid on time, their scheduling is always done properly, that he likes their other subs, and that Builder B is pretty anal about getting things done right.

 

All in all, a pretty stellar review from all 7 people interviewed. I’d say that you couldn’t have asked for more raving reviews from past clients, business colleagues, and current subconsultants. A true testament to the work that Builder B does.

 

Builder D

Builder D gave me a list of three past clients to whom I could call for references. Not quite the list that I received from Builder B, but I also didn’t ask for any others…find out why:

Reference 1 (Ms. T): I called Ms. T but she didn’t answer and her mailbox was full – no luck there.

Reference 2 (Mr. B): Builder D both designed and built Mr. B’s house about 8 years ago. He said that he’s known Builder D for a long time – they live near each other and he considers them friends. He said that Builder D was easy to work with, and that he had great ideas for the home – very creative. He said that Builder D tried to keep the project within budget, but it ended up costing Mr. B more…I had to ask more about that statement. Mr. B went on to say that Builder D tried to get them to choose more inexpensive finishes to stay within budget. Mr. B went along with that, but was ultimately unhappy with the cheaper decisions and ultimately paid again for the item that he wanted to get originally. He also said that the subconsultants would say that he’s pretty hard on them – always beating them up on pricing. And that he cycles through subs pretty frequently (isn’t that a red flag?). Mr. B said that he has issues with the sheet rock (cracking) within the first year that he moved in and he’s also had cracking in the concrete walkways around the house (likely due to poorly compacted soils). Builder D still hasn’t been back to fix the problems (although he’s been contacted many times). Mr. B said that in the end, it wasn’t the customer service that he expected from Builder D and that he was pretty disappointed. I always asked each person if they would use that builder again and Mr. B was the first person that actually said, “No”. He said that he would likely choose someone else. He caveated all that by trying to end on a positive note by saying that truly there are more “pluses” than “minuses” when it comes to Builder D, and that he does build a quality house. Um….ok.

Reference 3 (Mr. A): Similar to Mr. B, Builder D designed and built Mr. A’s home 5 years ago. He said that Builder D did a phenomenal job. He really couldn’t recommend Builder D any higher. He built Mr. B an 8,000 square foot craftsman style house and said that there’s a high level of detail in all of the finish work. He said that he’s easy to work with and that schedules are up to date and really lets you know when you need to make all of you selections so that you don’t affect the schedule’s critical path. He too said that Builder D pushes you to choose cheaper options for finishes to stay within budget. He said that Builder D has a high level of integrity, good subs, and detailed bills/invoices. I asked that since it’s been 5 years if there’s anything that’s had to be fixed or didn’t come out as expected and surprisingly he said that yes there was – there was cracking in the sheet rock (just like Mr. B), and that windows were missing caulk so wind would whistle through them, that the front door needed to have the wood work re-finished due to rain damage, and that the entire exterior of the house needed to be repainted this year because the first job was horrible and that the color was already fading from charcoal to heather gray. Mr. A mentioned that he lived right next door to the house while it was being constructed, which prompted me to ask if he saw anything during construction that wasn’t done correctly. He said that one time he had to point out to Builder D that some of the lumber was really bowed and in pretty bad shape – of course Builder D made sure not to use those ones then. He also said that Builder D would repeatedly say, “this doesn’t look right” a lot of the time. Mr. B said that was because Builder D was really picky about style/workmanship. I think it means that Builder D doesn’t have very educated/quality subs working for him so a lot of things need to be redone. Again I asked if Mr. B had to build a house again if he would choose Builder D and he said that he would!

 

I was absolutely shocked when I got off the phone with the two references from Builder D. I was practically begging people to tell me something bad about Builder B – any sort of dirt and they couldn’t. I talked to two references for Builder D and both of them told me what I consider to be bad things about Builder D. I was absolutely stunned to hear about all of the issues that both of them have had since their home was built. And isn’t it weird that none of the homes are ones that were recent – they were from 5 and 8 years ago? I think that must say a lot about the workmanship that he’s currently performing on the houses he’s building now (or has recently built). It was such a surprise to hear negative things from Builder D’s references – we really enjoyed meeting and interviewing him, and truly felt like he would have been a good fit for us. I guess that’s why people say that references are so important – some people are just good salespeople. I guess he still hasn’t learned that actions speak louder than words.