Hello, the duo is back for episode #17.
It's hard to believe we're already on the 17th episode.
Honestly. We come at a time in between the
the holidays where sometimes things are slowing down a little
bit, but certainly not for us. We've been fairly busy.
But before we jump into it, you want to take a second to talk
about your Thanksgiving. How was it?
Yeah, yeah, it was good. We hosted at our house actually,
which was fun. So we got to have several people
over here and a lot of good food.
And yeah, it was it was a really good time.
What about you? I know you were not even on this
side of the pond, so to speak. Yeah, I had a had a little jump
over to Europe for for some things but did get back in time
for Thanksgiving. So real low key and I listeners,
you can call me a little bit crazy, but actually ran a 1/2
marathon all by myself during during Thanksgiving Day.
So got to come back and feast up after that.
So yes, I am crazy. There you go, getting ready for
your half Iron Man. Awesome.
Yeah, something like that. Well, let's jump into this.
Today, we wanted to talk about financing a custom home.
So what, what does financing look like?
What does, what does that even mean, right.
I think we all know what financing means as in general,
but but how does it relate to designing and building a custom
home? When do I need to get the money?
If I'm going to, if I'm going to finance the home with a
construction loan from a bank or a third party.
So that's really what we wanted to, to briefly discuss here
today. Steven, you want to you want to
kick it off for us? Yeah, Yeah, sure.
And like you said, yeah, I mean we're specifically keeping this
to new home construction financing and it also will
really just encompass custom homes.
You know, I know production builders or some of the big box
builders actually offer their own financing or we'll build the
home, you know, on their dime and their dollars.
And then if you bust out, you know, the home is very similar
to all the other ones that they build.
So it's fairly easy for them to turn around and just sell it in
a neighborhood 30 in and they're already building right around
the corner and possibly even built the same floor plan.
So excluding that market, right. This is what we're talking about
is specifically new home construction for custom homes.
But with that clarification, yeah, you know really there's
two different types of financing that we have seen most
prominently when we're working with clients and that is cash or
a construction loan. So I think cash is somewhat
straightforward. You know, people still do have
plenty of questions and how does that look, you know, when do we
pay different draws and how do we pay the builder versus the
subcontractors? How does that all split up?
So that's something we'll talk through, but mostly the
construction loans are where you know it takes a lot of
coordination and it's it's multiple parties that are
involved and there's different things that have to happen.
Throughout the process to. To make the bank feel
comfortable giving people these large sums of money.
So, yeah, yeah. You have anything to add that?
Yeah let's let's take probably just about 10 seconds here to
talk about cash. If you are coming to a custom
home builder with cash to to finance your your build it's
it's going to be broken into payments for progress of
completion, right. So there's going to be a we have
we've done so much we get the builder gets whatever you've
agreed upon at at the in the contract right is is typically
how how that's most most often times going to happen with with
the cash financing with a construction loan it'll be a
little bit different. So when the money is is needed
to pay the bills there will be a draw request so, so we'll we'll
jump into that here in a second but just wanted to address the
the rest of this episode we're going to be talking more about
working with bank financing not too much cash.
Yep. And I'm I want to clarify on one
thing you said there too that when cash is involved, the
clients cash, if you're working with a professional builder it's
not uncommon and actually it's very common that the builder
will request draws and that draw will encompass all of the work
that has happened you know and that needs to be paid for, has
been invoiced and also the builders share of the amount of
work that's been complete just like you said.
So typically that construction amount that drawl as we're
calling them goes directly to the builder and the builder is
professional and divvies that up as it needs to be divvied up.
It's not on the client to pay anybody individually.
The client is making payments solely.
To the. Builder and the builder is
acting as the ultimate general contractor, takes all the money
in and splits it up accordingly so that everybody gets paid the
way that they have been contractually agreed upon to be
paid. So that's the way that it should
happen in cash or construction loans work the same way.
It's just who's. Fronting the money, is it a bank
or is it the the client? So, yeah, little differentiator
there. Yep, yeah, great point.
So really what how does a construction loan work?
Well, you're going to go, you're going to go to a bank and
request a construction loan, ideally before any construction
has started or even before. Even while you're in the design
phase, you can never talk to the bank too early because there's
obviously limitations on how much money they're willing to to
lend to anybody, right. It's going to be based off of
your financial picture, your assets and also your, your
income. So you'll go to the bank as
early as possible to at least get similar to like going to get
a mortgage on an existing home to see what you're, what you're
qualified for. You're qualified for say $1.5
million, right? That will also help the builder
understand, OK, what do you, what do you, what's your, what
you qualify for and what you are comfortable with.
Maybe two different numbers and that's perfectly fine, but it's
going to help us make sure that we're not doing anything out of
order and that we do have a way to actually finance the home
that that you want to build so that we're not wasting anybody's
time. So you go to the bank get the
pre approval for whatever whatever amount that is we sign
a contract the the builder and the and the homeowner would sign
the contract together for whatever is agreed upon in terms
of the the the floor plan the the specifics the the the
payment schedule and then obviously the the total the cost
right. Whether it's cost plus or fixed
price it it doesn't really matter.
Some banks will actually dictate I only I I will only allow
funding on fixed price contracts but that it's going to there's a
lot of things that vary from from bank to bank or credit
union to credit union. So we get the contract on the on
the with the builder and the homeowner and then from there a
lot of the paperwork, the typical paperwork of validating,
proving your assets, proving the the your income is there, just
having all that documentation and eventually you'll close on
the construction loan and typically the the cost to do so
is, is the closing costs. And then if the bank requires
any upfront equity or you know what we often often term skin in
the game saying hey there's more money that that needs to be put
into this either in terms of a deposit to the builder or into
some equity account with the bank.
Again variable on on the bank that you're working with and and
then that's it right. So then you we have this what we
call like an escrow we have a construction escrow account it's
it's your money it's it's your funds the the liability is on on
you as the homeowner and then we're we're ready to start
building right. So really we'll we'll finish the
rest of this, but but that's that's all the work that has to
be done concurrently while we're working on a plan set, while
we're working on finalizing that that dream home and what you're
what you're after. While we're even up to the point
of doing permitting and and other approvals with the
neighborhood and things like that.
So there's a lot of concurrent things going on and this is
certainly one critical one to make sure that we can move
forward and and pay the pay the cost to build this thing.
Yep, Yep. And I think you touched on it in
there that there actually are a lot of checks and balances in
this system. You know the bank isn't going to
give you more money than you qualify for.
They're also not going to give you more money than the
completed project is going to be worth.
So they do an appraisal just like they would on an existing
home. They'll look at the floor plan.
They'll look at your selections or your finish outs that you're
going to have in this home that's to be built.
They're going to look at even the builder's track record a lot
of times because the bank doesn't want to get in to a
partnership with a a builder that they have very little
confidence is going to finish the job to the way that they say
it's supposed to be finished. So the bank is doing a lot of
things to help protect not only your assets but also the bank's
assets as well, which is the majority of where these
construction loans come from often times.
So like we were saying, you know, there's a lot of checks
and balances there and it it's good for the clients, it's also
good for the banks and it's good for the builders to you know,
builders know that they're building within a scope that
everybody's comfortable with. The bank is comfortable with it,
the homeowners are comfortable with it and the builder in turn
should be comfortable with that as well.
So all checks out there, but you were finishing up your point by
saying that we are now at the point where we have a an escrow
account, so to speak, of money that we can use throughout the
build. So where do we go from there?
So you've closed on the loan, We've started construction and
we've started to incur cost to build the home.
At that point, we will request what is called.
We've referred to a draw from the bank.
So the way that works, a drawl of money, right, the escrow
account, all the funds, even after you've closed all the
funds are still sitting in the bank, right.
The money has not been given to the builder.
So again, as Steven said, there's a lot of checks and
balances. We request a drawl that
typically involves us documenting what were how much
money we are requesting, where it's going to go and for what
expenses, whether it's a fixed price contract or a cost plus.
Again it doesn't really matter. It still is agreed upon upfront
that hey this is, this is you know this is where this money is
going. The you as the client will
approve that you will sign off on it saying hey this is I agree
to this because you're seeing the progress of of the project.
So you know that there's obviously been expenses incurred
and then at that point we submit the documentation and in off in
most cases the bank will hire a an inspector to come out and
really just take pictures. They're there to just take
pictures for documentation purposes on the progress of the
home. They are not checking for
quality, they're not checking for anything else other than
they're to take pictures, show proof that this is the house
being built on this particular lot with the builder that we've
agreed to do business with. Again, checks and balances.
From there it goes back, they approve everything and then the
money is wired directly from the bank to our bank account so you
do not see the money. However, you will typically get
a a monthly statement very similar to like a a personal
checking account saying hey, here's here's how much money has
been drawn on the on the escrow account for this construction
loan. And then typically with that
statement comes the interest that you owe on that.
Whatever interest rate you have agreed to in that contract will
be OK. You're only paying interest on
the money that has been drawn, not on the money that is still
sitting in the escrow account with the bank.
Yup. Yeah, that's a a really good
point there that you just talked about is that a lot of times
these construction loans are interest only throughout the
build and so that plays well with building quickly number
one, but it also does not play well with higher interest rates
of course. So you know it's it's definitely
something that it's a progressive thing.
So it only accrues interest on the amount that you've taken out
from the bank. So if it's first draw and you
took $100,000 out of your $500,000 escrow account or
amount that you can fully draw from, you're only getting
charged interest on that 100,000 until you pull your next draw.
Then it increases that of course and then you're paying more
interest per month. So you know it's, it's a
progressive thing and it actually helps throughout the
build that you're not paying the full amount of interest on the
full loan amount from the very beginning.
That's typically what we see. Of course, every bank might be
different. Credit unions are usually some
of the most lenient and flexible, sometimes have the
best terms. So check with your local credit
unions. But we've seen good success
working with those and yeah, so. Just a little little insight
into the from a builder's perspective, we are constantly
incurring costs on that build weekly as long as the product,
the project is progressing, right.
So another another of many reasons to make sure you've done
your due diligence on selecting a professional builder is making
sure that their accounting and their bookkeeping is, is in
tight order because they need to code those costs to the
appropriate house appropriate project.
And as you can see how this works, the builders going to
have received so much money at any given point in time, right.
But the costs are going to be either over or under.
Very rarely are the costs going to be at that exact point in
time the exact same to the money that has been drawn.
So you're always either over or under what what you need, right.
So the the point in me sharing this, what you need from, from a
builder's perspective, mind you. So the point in me sharing this
is that you want to hire a professional builder because you
need to make sure that they have a well run operation financially
that when they have. For example, the the builder has
taken 200,000 in drawls, but the expenses are now 250 two,
175,000 because there was just a big payment to for example to
the the drywall company or the OR the framer.
There's there's many times where the builder just needs to be
able to have the proper cash flow to carry that until they
get the next bank draw, right. It's not it's it's just too much
paperwork for everybody including yourself if the
builder is requesting A drawl every other day, right.
So typically what we see to minimize the amount of paperwork
for all parties involved is anywhere between 5:00 to 11:50
draws for the entire project. So I just want to share that
little insight from the builders perspective to help you
understand how it's managed. So it might be that we've we
have $200,000 of money for the project, but our expenses are
actually 275 and in that next draw it's meant to to catch us
up, right. And then it could be the flip
side in that, oh, we have actually drawn more money than
the expenses, but we're about to very soon incur other expenses
that are going to catch us up. So it's a constant overage and
underage until you get to the very end to be rest assured.
Again, with a professional builder at the very end,
everything is trued up to what you agreed to in that contract.
Yeah, that is a fantastic and very important point that maybe
I can try to recap here so that people hear it another way.
Working with a professional builder is the key there that
the worst thing you can do is find a fly by night small
builder that quoted your project aggressively.
I'll put it that way or you know under bid your project and then
they don't have their own financial backing to be able to
carry those times where the construction draws are less than
the amount that has been invoiced for the job.
Then you've got delays in construction If trades say hey
I'm not coming back until I've been paid builders not caught up
on payments or you know whatever the case is.
But man, it's that would be a really tough position to be in
if you're working with a small, unprofessional, whatever, even
just a a builder that is not organized.
I mean, that could be enough right there that they're,
they've got job costs coming in from different jobs and they
can't keep them straight because their accounting is not good
enough. Or they're not using efficient
QuickBooks or whatever their accounting methods are.
They're getting everything mixed up.
And then next thing they know they've taken too much of A draw
on one house and not enough on another.
It's financial. Accounting for custom home
builders is a huge beast. I mean, it is a it's a very
tough topic and even accountants have a tough time with it if
they're not familiar with custom home builders.
So I say that not to scare people and not to, you know, not
want to work with a custom builder, but it just is even
more of a supporting argument to go with a builder that you trust
and a builder that has a good track record and a reputation of
being a professional custom home builder.
Yep. All right.
I want to make it very clear that just because a builder is
is large doesn't mean they're in a good financial place, right?
They could be, but they may not, right.
And that's really part of again doing your due diligence because
at the end of the day you can be a multi $1,000,000 home builder.
But if you don't have good cash flow, we've seen it happen
Steven and it's it's a horrific experience for the homeowners
where they're and and we'll digress after this because I
think that it it it can get way more complex but they can be
funding they can be using construction draws from 1
project to pay bills for another.
So again, it comes down to organization and the builder has
to be very aware of their finances to make sure that
everything is in order, that they're using that that money
for the right project. And that again, cash flow is key
because there's a lot of bills coming in and out.
As you know, we don't have to state the fact that home
building is capital intensive and it's always going to be that
way, right. That's just the nature of the
industry, nature of the business.
So it's it's the home builders that have mastered that and you
have their trust that you can. Affect a smooth pleasant
experience, but that that's really key.
And again, I want to reiterate the fact that that's not to
scare you, but this is just we want to share this because we
want to educate everybody that that is listening to us.
Yeah, yeah, yeah. And good differentiator there.
That size actually doesn't matter.
It's a really good point. And actually some of the bigger
builders get into bigger trouble because they're doing the wrong
thing and have done it that way for however long it took them to
get big. And their problems are
multiplied. It's just a bigger problem.
It's the same problem they had from the time they were small,
but now it's just a bigger issue.
So can even be messier as you get bigger.
But yeah, that's a really good differentiator that yeah, you
just you need to find a builder that is doing well cash flow
wise and is a reputable and honest builder.
Yep. So I just I I would, I'd like to
sum this up or wrap it up. As you know, there's a lot of,
there's a lot of things that the bank needs just in terms of
documentation. There are checks and balances of
course to protect every party as there should be.
And every bank that we have worked with, they've been fair,
they've been equitable. And you know it's it's really
about just communicating when things come up.
We've had minor issues come up and you work through them,
right. And and I think that's just what
that's the mindset you have to have going into it.
Now the the last thing I want to state is really two things.
Again, you cannot start talking to the bank early enough.
The amount of time it takes from beginning discussions and
interviewing banks on which ones you like more than others based
off of how they're going to service you, what their interest
rates are and all those other things that are important that
may be important to you. I would say it it's going to be
anywhere from as short as four to five months up to six to nine
months and I know that's a wide range, but working with the
banks to get a construction loan does not happen quickly.
So that's six to 9th month, 6 to 9 month.
Time frame that I gave you is, is from start to to actually
closing on the loan saying hey we can begin construction and
start pulling draws. And by the way the bank will not
allow us to start construction until the the that a loan has
been funded typically. So there is a timing element
there as well. We can't just start construction
and be a certain certain way through the project and then go
to the bank and say OK now we want money right or now we want
to close on the loan and they they will not allow that.
So really Steven, that's that's how I'd sum this up.
I think is hopefully insightful for our listeners here on on
just a little bit more about financing, I at one point in the
past I'm inactive, but at one point in the past was a licensed
loan officer in the state of Texas.
I never actually funded or did any construction loans.
It was your traditional traditional and conventional
mortgages, but funding and financing home homes and and
real estate is is all similar at at some level, right?
So really good stuff, Steven. Yeah.
Yeah, absolutely. Good points there.
And yeah, you know, I I think that you did a great job of
summing it up and provided a lot of value for all of our
listeners being like you said, a licensed mortgage or loan
originator in Texas. Former.
Let's get that clear. Not anymore.
Yeah, don't hold us accountable. But yeah, you know, even more
than that. I just want to tell the
listeners too that you're you're always on top of our
construction loans and you run all of our finances on our end,
of course working with an accountant and everybody else
that we need to. But you know without you our
business would not be as as successful as it is I guess is
the best way to put it. So want to thank you for that.
But also just let the listeners know that it's not hollow advice
that's coming out of your mouth or mine.
We've seen plenty of construction loans in our time
of building homes. We've seen successful ones.
Luckily we have not seen any unsuccessful ones and there's
reasons for that, right? We have cash, buffers and all
kinds of stuff in place in our business and we work with
reputable banks and and we're a reputable builder.
So it's a good combination. When we start a contract and
start building a home, we drive it from start to finish.
And our goal is to make it as smooth and painless of a process
for the clients as possible. We don't want to have any, you
know, contention or anything like that with the banks or the
financial partners. That's the last thing that we
want and that it can just throw a wrench in any build.
So yeah, we're always on top of that and always looking out for
it. But hopefully this episode has
shed some light for anybody that's, you know, questioning
construction financing. Like we said, it is a beast and
it is a huge topic and there's a lot more to it.
But hopefully this was a good kind of high level overview,
just enough so that the listeners feel comfortable
picking the right builder and then knowing kind of what to
keep their guard up on and and just be more informed on making
decisions in that realm. Yep.
And and I want to make sure we just address this last thing and
we'll wrap it up. I we don't want to overwhelm
you. Once you understand the process,
everything is is typically more streamlined in your and you can
feel comforted that OK, I understand what's going on and
I'm comfortable to proceed. Right.
So really the purpose of this episode is just, yeah, at a high
level to share with you how it works.
It is a beast, but that's not meant to overwhelm anybody.
Once you understand things it's it's it can be really smooth
sailing and a great experience. So Steven, thank you for your
time. Yeah, absolutely.
Same on your end.