When planning for the construction of your new home, the first step you need to consider is to create your budget. The budget will detail out how to distribute the funds efficiently in broad terms.
The budget will provide limits on spending and helps with the preparations of specifications and plans. This prevents financial disasters. Once you have finished the cost estimating process, you can develop your final budget.
Here's a common scenario.
For instance, a family wants to build a new home. They will spend potentially months or even years collecting magazine clippings and photos of products and features they want in their home. They now have an arsenal of sketches and ideas they have about their home. From layouts to front excavations, they now decide to hire an architect to begin designing their dream home.
They complete their plans and show it to the builder and supplier. The cost estimates come back three times higher than what they can even afford. From there, the family has to take a reality check and downsize the rooms and cut out features to reduce the cost.
Before beginning, they are building a home that is water-down from the dream home they wanted.
We have a better way for you.
1. Figure out how much you want to spend first.
2. Establish the costs per square foot in your desired area to build.
3. Have a preliminary budget sheet ready.
4. Adjust the upgrades, extras, and square footage to meet your spending limits.
Figure Out the Limits to Your Spending
First, you need to figure out how pricey of a home you are building. An even better question is asking yourself how expensive of a house can you afford to build. For most individuals, you want the best home you can afford.
On the contrary, if you have a lot of disposable income, you may be able to afford more than you need. It will depend on your specific situation. Many people already have a ballpark estimate of how much they can afford or want to spend.
You want to start from the end and work backward to determine how much you can afford.
Firstly, you need to decide out how much you are willing to put down or how much cash you have. And then also determine how much you can afford to pay in monthly payments for your loan.
Formula to Qualify for Loans
Determining how much you can afford isn't all that hard. Realtors and lenders do it all the time. We classify lenders as insurance companies, banks, savings and loans, credit unions, relatives, or any other source.
Typically lenders will use a formula to see if you qualify for a loan by determining how much you can pay each month. The formulas will differ from bank to bank. They will compare your income to your debt payments.
Take your monthly payments, which include your car loans, charge cards, house payment (do not include food, entertainment, utilities), and divide that number by the total sum of your monthly income. That number should not exceed a .33 to .36. It also depends on the percentage of cost for the home you are planning to build.
Another rule is that the monthly house payment you pay for should not exceed about 25% of your monthly income.
Principal, Interest, Taxes and Insurance
These are four elements that determine the qualifying formulas. Part of the monthly payment goes to paying off the principal, which is the amount of money that was borrowed.
Part of the payment goes to last month's interest, which is the amount you still owe.
And we'll cover a brief description of Taxes and Insurance
You also need to pay for property taxes. The county, city legislate these, and sometimes the local school board. The taxes are due each year. Sometimes it can be quite a lofty sum of money depending on where you live.
If you don't pay the property taxes, the government can take and sell it to get their money back. The lenders will also use the home as collateral, meaning they will take them home to ensure their payment.
What if you didn't pay your property taxes and the government foreclosed, how would the banks receive their money? Many lenders or banks will approximate an annual tax bill and force you to pay 1/12th of the amount monthly in addition to your interest and principal.
This money is collected in an escrow amount. By the end of the calendar year, the lender can pay the tax that is owed on your home using the money from that escrow account. This guarantees that the taxes are paid.
Lenders also worry about the possibility of any damage or destruction that could happen to the home. This would wreck the value, and the house can no longer be used as a fair collateral. Examples of damage could be from a tornado, falling tree, or fire.
This also means the lenders will force you to have a home insurance policy to ensure that the funds will be there if your home needs any accidental repair damage.
All of these elements: insurance, taxes, interest, and principal are the big pillars used in the qualifying formulas for lenders to figure out how much you can afford. Also, some lenders include factors such as income taxes, and maintenance of a home such as repainting, broken items, or repair of worn.
If you know your monthly debt obligations, how much money you are willing to put down, your income, then a lender or realtor can help you. They will use their experience with property taxes, standard amortization, and current insurance rates to determine how much you can afford for your home.
This can be done in just a few minutes. You can use a resource such as the website nolo.com to calculate how much can afford.
We've included a table below to give you rough estimates, so you can see the relationship between mortgage amounts, monthly payments, interest rates, and annual income that you would need. In this example, we are assuming a 30-year loan. The insurance and monthly taxes are assumed to be 12% of the total monthly interest payment and principal.
Contact a Professional
If you're still having trouble, don't worry, this can be fixed in just a few minutes online. First, just calculate your income. Then add up all of your monthly payments that you are obliged to pay long term and decide how much money you will place down for your new home.
Next, call a real estate agent, credit union, or mortgage bank and ask for their help.Make sure to tell them how much money you have, your monthly gross income, monthly payments for your obligations long-term, and how much you can afford for your new home. It's as simple as that.
You also need to ensure that you include the builder's profit. For instance, let's say you can afford a $300,000 house. And then we assume the builder's profit is about 15 to 20%. That means the cost would be around $345,000 to $360,000.
Cost Per Square Feet
You then need to create a budget for this home and estimate the square foot costs for other tract homes in your desired area. This might sound odd. But why would you need the square foot costs of tract homes?
We'll soon tell you the reason. But first, how do you get these square foot costs? Well, you will need to make your best-educated guess and do a bit of detective work. Here's how to begin.
You need to take a visit to some subdivisions that are under-construction. Ideally, this is an area you intend to build and find a home. Ensure that the home is similar in quality and size to the one you're looking to build. This will be your comparison home. Make sure to get the sales price and size of that home in the exact square feet. You can simply get this info from the sales agent.
Please note: The square footage will include heated areas meaning that the unheated areas like the basements and garages aren't included in the square footage. It is also measured from the outside wall to the wall.
You then need to subcontract that actual cost of the entire lot and include the builder's overhead along with their profit to get the true cost of construction. Now, this is where you need to run a rough estimate.
Most subdivisions, the lot will be looking at around a 25% value of the home. To be a bit conservative, you can use a 20% value. Note that it is most subdivisions but could be different.
For example, an ocean-front property would increase the costs by much more. You need to use your judgment in this case. You can check what other lots are also selling for.
The original builder of that subdivision probably paid less since they could have bought a few lots together or raw land. So you might need to lower the cost to reflect better what the builder has in value when comparing to your own.
For the builder's profit and overhead, we typically use a very modest 15% ballpark estimate. It might be much higher, but this conservative number helps you stay in your budget.
So what have we got so far? Take your price of the comparison home, divide it out 15% for overhead and builder's profit, and divide up another 20% for low costs. This adds up to 35%. This means you still fall within the range of the .65 needed to qualify!
Next, divide those numbers by the total heated square footage, and you will get an estimate of a cost per square foot for the home that is similar to your home you're looking to build.
Formula = (Price x .65) ÷ total heated sq ft = cost per square foot
Is this accurate, right? Not exactly. But it's way better than pie in the sky guess! Calculating the square foot costs is great for comparing the housing costs between the varying areas. It's also good for getting an idea about the quality of the home's quality of finishes and features. For instance, a home that costs you over $200 per square foot is much fancier than a similar-sized home that costs $100 per square foot due to the quality of home.
Also, think about this. Let's say a home has an outside dimension of 40' x 50' and an area of 2,000 square feet. This brings the length of the exterior walls to be about 180 linear feet (50+50+40+40). Now imagine another home with the outside dimensions of 25'x80'. And it's area is 2,000 square feet as well. However, the total linear feet is 210!
So now you have to assume that building outside walls has an associated cost. And you also need to account that the second home costs more due to the outside wall.
This is only to show you that the square foot costs just a rough guess and doesn't give you the entire picture. Having a good comparison home with a similar finish and size is a good starting point for budgeting.
Just keep in mind that budgeting for your new home is a planning guide! The hard numbers will be there once the design and cost estimate is completed, and the materials and actual labor have commenced.
Complete the Home Building Budget Sheet
Next, you need to decide on how your new home will be different from your comparison home. You also need to factor how these changes will affect the costs.
This is where the budget sheet comes in handy.
How to Fill it In
Many of you probably own a lot, so fill in the amount you already paid for. If not, then just guess the amount you will pay for.
Next, fill in the per square foot cost using your comparison home as a guide and the estimated size in square feet you plan on building. Multiply these two numbers together, so you get a base cost for your home.
Then you need to figure out the nitty-gritty about the different features. For example, do you want a better window than the comparison home?
How about nice cabinets or appliances? Or even better light fixtures? If you'd like this, you need to contact suppliers to provide cost estimates for any downgrades or upgrades. Now plug in the numbers and add it all up. Now, is it more than you can afford to spend or less? If it is more, then you'll need to find areas to cut down on.
You can adjust and play about with the extras, upgrades, and square footage until it meets your spending limit. Just continue the process until you get a budget amount that fits your needs.
Then you need to work with an architect, and they will get you a detailed plan within your budget!
For those of you building your first home, you should be realistic. Don't think you can afford everything when you can't. But maybe you'll find that you can afford more than you originally thought. That is a great position to be in. If that's the case, add the features you'd like and put the builder's profit.
Now that you've created a budget for your new home, you can now focus on identifying and purchasing a lot.