Financing your project
Financing the building of a new home it is very different to arranging finance to buy an existing one, so it is really important that you work with someone who understands all the complexities of building finance. These days, the absolute least expensive rule of thumb costing for building work is around $1500 per square metre (and this is hard to do), $2500-$3000 per metre for more upmarket versions and upwards for luxury.
The best time to work out your finance is when you first start thinking that building may be an option for you but you will not have a clear idea of what your project will cost until you’re some way into the design stage.
It may be better to start with working out what you can afford – talk to your bank about what they will be willing to lend to you based on your ability to service the mortgage and then you can work with your designer to fit a project into your budget.
What Can You Afford?
- Building is an expensive exercise: plan, plan, and then put aside a little more time to plan. This will help your budgeting.
- Budgeting is not a vague hope – it should be an accurate and specific target by which to stick with as much as possible. The building process itself is stressful enough on you and your partner and your suppliers, without having the added strain of financial difficulties.
- Why not investigate your alternatives to building beforehand – for instance, will it be better and more financially viable to sell and move to a home that will give you what you want?
- Everyone wants a million dollar home but there are few of us who can have enough money, so the name of the game is compromise. Make sure you give yourself a budget you can afford and try to stick to it in spite of all the temptations.
- Avoid changes to designs and materials if you can – changes cost money, not least because the tradespeople can deviate from their quote when you deviate from your brief. ( See our Budget Worksheet ).
- These days, the least expensive rule of thumb costing for building work is around $2000+ per square metre but you’ll have something very basic for this, $3500+ per metre for more upmarket versions and as much as $6000+ and upwards for luxury. And allow at least 10% for overruns, unforeseen costs or changes to the plan – you are likely to need it (and if you don’t need it then you can have a great housewarming party)! Please note that the rough costs are so general that even the Ministry of Business, Innovation and Employment who now run the building sector in New Zealand have taken down any guidance off their own website.
- Working out the cost becomes a very complex procedure and can take builders up 160 hours to do one quote for one house. A quantity surveyor is highly recommended – they will give you a very accurate assessment of the cost of building prior to you starting and it’s better to spend a bit upfront and find out you can’t afford the true cost before getting halfway through the build and running out of money.
Paying For It
For most people, unless you have cash saved,, borrowing against the current value of the house to do an extension, or borrowing against the final value of the finished house if building new, is the usual way of financing a building project.
If you’re doing a renovation or addition, the first thing you will need is a valuation before you speak to a bank or mortgage lender because that will let them know how much equity (money) you have in your house. Alternatively, you will need reasonably detailed drawings of your new build for a valuer to give you an accurate value of the finished house.
On the other hand, letting the financial institution know how much you’re looking to spend may save you the time and money of getting the valuation if your financial situation is tenuous.
How to finance your new build
Whether you’re designing and building yourself, or buyingoff the plan, there’s nothing more exciting than a brand-new house.
Here’s what you need to know about financing your new build.
- New build home loan deposits
The good news is that mortgages for new builds are not subject to the Reserve Bank of New Zealand’s LVR rules.
This means that banks will be able to offer you a loan even if you don’t have the standard deposit of 20% (for home owners) or 35% (for investors). You may be able to get a loan with a deposit of as little as 10% or even 5%.
You will, of course, still need to meet all the lender’s other lending criteria, including credit rating and your ability to service your repayments.
- Negotiating terms
When it comes to getting a good deal, new build home loans are no different to any other mortgage. You should still shop around, compare interest rates and fees, and negotiate terms and conditions.
With an experienced home loan broker working for you, you should still be able to take advantage of cash back offers and other incentives.
- The pitfalls of new builds
There are important traps to avoid when you’re dealing with builders. Be wary of paying a large upfront deposit before construction even starts, as your precious funds could end up being used to fund the builder’s other projects.
All too often, our newspapers are filled with horror stories of companies going into receivership, leaving buyers with half-built houses. You may be able to avoid this by negotiating a ‘turnkey’ purchase, where your deposit is held in escrow by the lawyers, and you only hand over the full purchase price once your house is completed.
- Financing your home during construction
It takes a long time to build a house. In the meantime, will you still be paying rent or a mortgage on your existing home? Often, banks turn down loan applications because the applicant doesn’t have enough income to pay interest on both loans during the construction period.
In some cases, an experienced broker may be able to negotiate with the lender to have the interest during the construction period added to your loan balance. This way, you’ll only have to service your existing rent or mortgage until your new home is ready.
- If you’re keeping your existing home
You can run into similar problems if you already own a property that you plan to rent out or sell later.
- If you’re relying on the rent from your existing home to help you pay your new mortgage, the bank may turn you down because you don’t yet have that income stream, and you can’t service the level of borrowing without it.
- If you’re planning to sell, banks may be reluctant to offer finance to bridge the gap between purchase and sale.
One way to solve this problem is to turn to an alternative funding source. However, this route may be more expensive – an experienced home loan broker will be able to run a cost-benefit analysis to help you decide if it’s a viable option for you.
- If you can’t get a turnkey contract
Sometimes, it simply isn’t possible to secure a turnkey contract. Even if you can, there is a risk – since a mortgage offer generally only lasts 60 – 90 days, and a building contract usually completes within six and nine months, you may have to reaffirm your financial position several times during construction.
What happens if your circumstances change and the bank decides to pull your funding during construction?
Although your mortgage broker can work with you to help make sure your application gets renewed, this is a definite risk. You can avoid it by crystallising the loan and drawing down funds to make progress payments, but as mentioned above you should be wary about handing over funds before your house is complete.
Be sure to take proper legal advice before entering into a contract, and make sure that your home loan broker is monitoring draw-downs and working with your bank to make sure you have enough funds in reserve to complete the build.
Don’t Just Talk to Your Bank
Shop around the banks, look at their websites and maybe talk to a mortgage broker. there are specialist providers for building projects and development proposals.
All lenders will want to know your:
- Annual income (before tax)
- Number of dependents
- Credit cards and their limits
- Fixed expenses in your budget such as hire-purchase
- The “one third” rule says that your mortgage repayments plus all other regular expenses should total no more than one third of your income before tax.
- Borrow no more than 80% of the total price of house and land. Prices can go down as well as up, so you need a buffer to make sure that you don’t end up owing the bank more than your home is worth.
- Get your loan pre-approved.
What sort of loan is best?
There are two types of home loan, with three types of interest payments:
- Table Loan
- The Principle is gradually repaid over time, with the make up between interest cost and original loan amount changing from mostly interest to more and more principle.
- You can either ‘fix’ your interest rate, or ‘float’ your interest rate. Fixing it can often be a little more expensive, but gives certainty around repayments and if intrest rates go up you don’t pay more until the term of the fixed loan expires. There is a cost if you wish to change the loan. Floating your loan means the interest rate is free to go up or down depending on economic conditions, so your repayments will change over time.
- Interest Only
- No repayments are made on the princible, just the interest owed – this results in lower payments but no reduction in the initial loan.
- Combination of interest rates
- You can have an amount you think you can pay off quickly on the unpredictable floating rate and the rest of it on the predictable fixed rate. Talk with your bank or mortgage broker about what will suit you best.
Points to remember:
- At the end of your loan’s term, it will convert to the current floating rate or you could choose a new fixed term.
- If your income increases you may be able to increase the monthly/fortnightly payments without any penalty, as long as you maintain the increased repayments for the rest of the loan period.
- If you receive any unexpected extra income, you can pay off all or part of your loan but the bank will charge a penalty for this if the repayment is over a certain amount determined by the size of your loan, which could be quite high unless your mortgage is on a floating interest rate.
- Buy the section
- Decide on suitable plans with your builder/architect
- Get it costed by a Quantity Surveyor
- Get a valuation, using the house plans and building specifications you have chosen for your new home. This is where an independent property valuer reports to the lender on what the property will be worth once complete. To do this they look at your plans, specifications and your vacant section
- Take a copy of your building contract to your lawyer
- Once you are happy with the building contract arrange for a copy of this to be taken to your finance professional so finance can be confirmed – Connect with an experienced home loan broker
- The building contract is normally confirmed at this point with a deposit paid to your builder. If you do not have the available funds to meet this then speak with your finance professional for guidance
- Progress payments commence
- Nearing completion of your new home you will be advised of a handover date. It’s really important you advise your finance professional of this date as early as you possibly can. The handover date is where you get the keys to your house in return for final payment. For the lender/bank to release these final monies they will need:
- A copy of your house insurance starting from the date of handover. Your insurance must include your lender as an interested party
- A completion certificate, provided by the valuer, so the bank knows the house is fully completed
- A Code Compliance Certificate, which is issued by the local council. Your builder would normally arrange this once all work is complete although unless specified in the contract you are ultimately responsible for this.
Escrow – Protect Yourself and Your Builder
Escrow is woefully underutilised in New Zealand. In this situation, you pay your money into a Trust account held by a third party that is guaranteed.
Your builder is confident he’ll get paid because the funds are there and available…but not until he’s done the work and to a sufficient standard. You can remain confident that you only get to pay when the work is finished and to a standard you’re happy with.
We’re happy to recommend the Building Disputes Tribunal…
When you’re building the funds are advanced by progress payments to your builder. This ensures that you are only paying for work the builder has done at anytime. It’s really important that you never owe more than the house is worth at each stage of building.
Normally when a builder invoices a progress payment, the bank will want to see an updated progress report from the valuer. This report is generally a one page and will tell the bank what the property is currently worth and what the cost is to complete. The bank will then pay the funds out to you at which time you would write out a cheque to your builder.
Contract Works Insurance
Arranging the insurance for the construction of your new home is an essential part of the planning of the project. Without appropriate cover being in place you risk everything – would you really want to risk your dream home going up in smoke and not being able to afford to rebuild it?
For more information about mortgages see Consumer NZ. Some of this information is free, but for some you will need to subscribe to get specific information.
Third Party Builders Guarantees
Building a new home is probably the biggest investment you’ll ever make, and if anything goes wrong it could be the most costly too. It makes sense to reduce your risk by having an independent builders guarantee in place, just in case something does go wrong.
This will help you finish the build, and fix any defects, if something happens and your builder isn’t around to do so. Some mortgage lenders now require them before they will give construction loan finance. See our Third Party Builders Guarantees page for more information.