Owner Builder Home Loans

WHAT’S THE PROCESS OWNER BUILDERS GO THROUGH WHEN IT COMES TO GETTING FINANCE FOR THEIR HABITABLE (Class 1a) BUILDING PROJECTS?

RedCap Finance Brokers

Why is Finance is So Hard to Get For Owner Builders of Habitable Homes (Class 1a)?

Land owners who plan to build on their land and either carry out the building work themselves, or coordinate the necessary tasks to construct the building are considered to be owner builders.

If the building work is being done with the view to sell or let the land or buildings, then it is highly recommended that a licensed building work contractor be hired to undertake the building work.

Banks Do Not Like RISK!

Banks view that an home built by an owner builder a higher risk as it reduces the size of the pool of potential buyers due to building work insurance and quality of work issues.

So if you choose to DIY your HABITABLE Kit Home Build Project then here are some steps you need to understand.

Step 1  Understand what you can afford to invest (borrow)

An Owner Builder (OB) usually has a rough idea of what they can afford and what they want to spend. At this early inquiry (pre-approval) stage, I like to have fairly accurate estimated figures to use as a starting point.

As a finance broker, what I’m after from You at this stage is:

1)         Value of the block of land (if already purchased)

2)         A rough idea of what you want to spend on the build project

3)         Estimated building cost

4)         Project value at the end of the build

I then work backwards from there and determine what can be borrowed and what an OB can afford based on their income. Although the loan cannot be submitted at this point, the OB at least has an idea of what they can borrow.

Fun Fact: Even a Licenced Builder building their own home is classified as an OB in the banks eyes.

Step 2  Get a detailed cost of the build

Once an OB has decided to go ahead with building a kit home, the next step is to work with a Draftsperson (or Architect) to get detailed site specific plans drawn up in order to obtain the necessary town planning, building, and plumbing approvals.

When a builder does the work on behalf of an owner, it’s the builder who gets all the associated costs and includes them in a contract. Under the OB scenario, the bank expects the OB to get the same detailed information.

There are 5 stages of a build to consider –

  • 1) slab
  • 2) frame
  • 3) lock up
  • 4) fit-out and
  • 5) finishing’s.

Once the plans are final and all relevant approvals have been obtained from council and/or private certifier, in order to get finance for your project, The bank wants an OB to supply a detailed costing of each of the 5 stages. It’s no use saying I think it’s going to be around $30,000 to do the foundations and about $40,000 to do the frame.

The banks are not interested in a general overall cost estimate – they want specific information.

Step 3   Engage a 3rd party to determine project costs

It's here that I recommend that an OB engage a Quantity Surveyor (like BMT Quantity Surveyors) because banks like an independant 3rd party to sign-off on the cost of the build. The 3rd party could also be an architect, registered builder, or civil engineer.

I like the OB to engage a Quantity Surveyor because they seem to provide the most detailed reporting and usually break it down step-by-step. The OB then gets this detailed report. You can engage the Quantity Surveyor to stay with you throughout the build overseeing each stage.

A few key points:

  • If there is a discrepancy between the OB total build cost and the Quantity Surveyor's build cost, the bank will take the Quantity Surveyor quote over the OB’s.
  • It’s the Quantity Surveyor who signs off on the individual progress payments i.e. they verify that the work has been done at the end of the stage. This is an expectation of the bank.
  • The Bank also sends out a Valuer to sign off at each completed stage.

What are the main differences between a traditional construction loan and an OB construction loan?

If a landowner engages a Builder to complete the entire build, it’s the builder who does all the costings for inclusion in a building contract.

However, under the OB scenario, as outlined in Step 2 above, the OB has to do the groundwork and get the cost verified by a Quantity Surveyor or other 3rd party.

The other key difference from a finance perspective is if a Builder carries out the build, a land owner can borrow up to 90% to 95% of the value.

For an OB the restrictions are greater. Generally speaking, banks lend up to 60% because owner building is a greater risk to the bank. As a direct consequence of increased risk, banks have tightened up their procedures and processes for this type of loan; mainly because there are many cases where OB’s ran out of money and the build was incomplete - and for the banks, the loan's security was greatly impaired making it harder for them to sell to recover their money.

This is why it’s important for an OB to understand what they can afford and have the detail to support the application.

It also really helps if an OB has equity in their land.

WHAT ELSE SHOULD AN OB CONSIDER WHEN GOING FOR FINANCE?

POINT 1 - Your Contribution is used up first!

I’ll explain my first point by giving an example (these figures are for the purpose of my explanation only). Let’s say….

  • Build Cost = $500k
  • Bank will lend = $300k (60% of $500k)
  • OB contributes = $200k (savings)
  • The bank requires an OB to use their money first i.e. the $200k per the example. When the $200k is drawn down, this is when the bank will start releasing progress payments ($300k) at each completed stage (stages of the build).
  • At what point the progress payments actually kick-in depends entirely on when the $200k is drawn down.
  • IMPORTANT:   The $300k is not released upfront. The $300k is released in progress payments.

The bank does this because they will only hand over the final balance of the progress payments once the Certificate of Occupancy has been issue.

POINT 2 - Upfront deposits are in addition to your Contribution.

WARNING: I want to point out that the $200k (savings) is not enough and thinking it is, is where some OBs get into financial difficulty.

When building, the OB needs to understand that they will be required to start putting deposits down on materials that need to be ordered well in advance (e.g. walls, windows, doors, and roof frame) of when you need them - these deposits do not form part of your progress payment contribution. However they become reclaimable after your portion of the progress payments have been fully made, and the lender's money becomes accessible.

It’s therefore highly recommend that such upfront deposits are covered by your project contingency money - that is over and above the $200k (OBs cash).

The amount of contingency is hard to estimate because what also needs to be covered in addition to pre-ordered materials are labour costs. A very rough guide might be 10% to 20% contingency.

If a client has equity in land, this money can be drawn on as contingency.

An OB also needs to be on good terms with suppliers. Negotiate good terms with suppliers as well as your trades.

POINT 3 - The banks want to limit their exposure to risk

The banks golden ticket is the Certificate of Occupancy and that explains why they don’t release progress payments until the OBs own fund is drawn down.

I want to stress again, the bank will only release money at the conclusion of each stage (once $200k is drawn down). The bank will not release money in the middle of a stage if the OB runs short. It’s only at the end of a stage and it has been independently verified as complete.

Other Tips

  • When you start making progress payment claims, the bank wants the detail of all paid invoices. It’s therefore in your best interest to keep invoices. In this instance, cash is not king.
  • Having cash savings or equity in the land (or both) is what will make the finance process much easier.
  • The bank also requires plans, permits, soil tests, insurances etc so make sure you have these.
  • Even a tradesperson such as a plumber or electrician doing an OB job should follow the same process of costing a job and include his or her own time.
  • Do your homework and know if you’re actually going to save money doing it as an OB.
  • Be realistic about the time you have to do the build because time is money.
  • Don't forget - if you want to sell the home - you may have problems with your potential buyer's bank not wanting to lend them money on an OB built home!
  • Like always - the Devil is in the detail!

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