WHERE'S ALL THE MONEY?
Where’s all the money going to come from? How can I pay for this?
Today we’re going to talk about all the various ways you can fund or finance your project. Find the perfect financing option for your home and discuss the 5 methods currently used to fund your dreams.
Here we go. We’re going to talk about money. The forbidden subject right. Nobody ever wants to talk about money. Even though its public knowledge people don’t like talking about how much they paid for their house or their remodel.
It’s too emotional, too personal. For some reason it just feels kinda dirty. Well today we are going to get into it. First I have to say that I’m not giving financial advice or legal advice with anything I say today. Before you make any financial or legal decision you should visit a financial advisor, cpa or lawyer. I am neither.
You see what I just had to do. Maybe that’s another reason people don’t discuss money. It’s just too scary… Well, lets get into it.
There are 5 methods used to finance and fund a new construction or renovation project. Before we get into the methods lets take a quick look a what you can afford.
First off you will need roughly 20% of the full mortgage amount to put down. Lets really get into it and also look at your living expenses, because it really is a large piece of your household budget.
Lets say that you make $150,000 a year of household gross income. After taxes you will be taking home roughly $100,000. Lets assume that you do not have debt. If you do have debt, either student loans or credit cards or some personal loan like a car or something I suggest paying off your loans first before you look to remodel or construct your house. I know that most people will not like to hear that, but that is my honest opinion. I believe you should have the least amount of debt possible.
Get rid of that high interest debt. You’re throwing your money away. If you follow the Dave Ramsey method you would get rid of the smallest debt first then apply the money to the next largest debt. You will knock it out quicker if you have a plan of action. Ok enough of the debt talk.
So lets assume that you are bringing in $100,000 each year, that give you $8,333 per month. Take 20% of that and pay yourself. This is paying yourself first for retirement and savings. So you put $1666 into savings or Ira or whatever kind of savings you want. Each month you are left with $6,666. The next thing I would suggest you do is build up your emergency fund. Your savings account is not your emergency fund. Your emergency fund is the money you put away for the immediate expenses. Lets say your refrigerator breaks or your transmission fails in your car. This will come from your emergency fund.
Most everyone I listen to recommends 3 months worth of savings in the emergency fund. I would prefer to keep around 6 months of living expenses, I am not there yet but that would be a great goal. If you are living off of $6,666 per month, then you need to have 20 to 40,000$ in this account depending on your level of comfort. Imagine having this amount saved. Would you be able to live more stress free? So thats just the buffer you have if something goes wrong. To get up to that 6 months savings put that 10% away, that 666 in each month. So your left with 6000.
Don’t forget you are putting 20% away on top of that each month. Each year you will be putting $20,000 into your longterm savings. Five years and you have saved over 100,000 plus whatever returns you are achieving with your investment.
Now that we’ve gone into savings and finances. After paying yourself first, you’re left with $6000 per month. Can you afford that house? Most banks will look at mortgage to income ratio of 28%. They are basing that on total income. So based on 150,000x.28 you get 42000 divided by 12 = a mortgage payment of 3500. But look at that realistically compared to what you are actually living off of once you have paid yourself.
That is over half, well over half and you will be including taxes and insurance on top of all that. It is not going to be feasible and pay yourself. If you want to pay your house first before yourself go ahead, but sit down with your budget and look at your future and determine if it is the right move for you right now. Something a little more reasonable would be approximately 1/3 of your monthly amount, so a mortgage of $2000 per month. That is a $350 to $400,000 home.
So what does paying yourself do for you? How does it relate to building or renovating your home? It allows you to get more for your hard work. This might not be the most popular opinion out there because it doesn't fulfill that instant gratification we all want. Who wants to wait? We all want it now. I so much want it now, its ridiculous. It’s difficult at times to take a step back in my life and say is this the direction I want to go?
Homes have become so expensive that a lot of us are forced to take a mortgage. Not just a mortgage but a high mortgage that really cuts into that future savings. So lets look at what our options are. Each of these go from costing you the least amount to costing the most amount. And you will see what I mean when I get into it.
There are 5 methods to financing or funding your project.
The first is Cash and Liquid assets - money you have saved from years of paying yourself first. This is zero interest money.
The second is Sweat Equity - how can you bring your time and hard work to the table. This is trading time for dollars. Still interest free but not always feasible or possible.
The third is a Home Equity Loan - now we are gradually getting into interest payments. Borrowing money. Don't get me wrong we all borrow money. I have a mortgage on my house right now and I’ve had home equity lines in the past. You have to be careful. When people are given flexible accounts like equity lines and they don't get used wisely like investing back into the house. It can become very scary.
The fourth is a Construction Loan. Typically an interest only loan with higher interest rate that can be converted to mortgage after the construction is complete.
The fifth is the worst way possible and that is with Credit Cards. People do it.
So we have 5 methods and they range from 0 interest to 20%+ interest.
If you are not at the point where you can pay cash for your project or the work is beyond what you can do yourself or a major remodel, the most commonly used loan for small renovations is a home equity loan. They are generally limited to under $40,000 but typically based on your home value and how much you currently owe on your existing mortgage. A Banker would be able to give you better numbers than I could based on your unique situation.
If the project is much greater, then you are most likely going to be applying for a construction loan. I have discussed construction loans in the past, but I wanted to quickly talk about one loan in particular. It’s called the 203K program.
And this is not to try and sell you a loan. I have no idea on who you would contact to start this loan and I am not recommending any banks. I just want to give you the knowledge so you can research it for yourself.
The 203K is a mortgage program that allows you to either purchase or refinance your existing mortgage and at the same time add renovation cost to the home you are purchasing. This doesn’t apply to new construction only renovations. The borrower has to show the money was spent on the house. Its not like a credit line in that way.
The construction has to be completed in 6 months and you apparently are only allowed to have 5 draws. So during a 6 month renovation that is pretty much monthly.
The down payment is usually small for this type of mortgage and is in the 3.5% down range. The total loan amount is typically below 300,000 but it varies based on the location of the home since some areas are more expensive than others. If you are doing a much larger renovation or new home this is not the loan for you.
If the renovation is around the 35,000 range and has no structural modifications then you can go through a streamlined process.
The bank is going to require you to have the plans of your renovation drawn by an architect before you close on the house. They want to know what you plan on doing and how. They also will not let you do the work yourself. You’re going to have to have a contractor doing the work.
I hope that this gives you a little insight into the various methods you can use to finance your project.
The last thing I wanted to say is
“If the time is not right for you financially don’t put yourself through the stress of trying to make it work. Take the time to explore your finances and understand how much you can afford, After you pay yourself first.”
I hope that you are having great success with the planning and construction of your home. If you want to get in touch with me please reach out to me on twitter or google plus.