Understanding a Construction Loan

[Martin D.]

Hello BP,

First of, I wanted to say how grateful I was to have had you throughout the whole process of learning about real estate. The resources on this website (books, podcasts...) are phenomenal and you, community, are awesome. So, thank you! :-)

Here's the story: I've been trying to buy my first house-hack/BRRRR property for the past 3 months in Arizona. The market is hot and it's harder than I thought. I placed offers on two properties but have been outbid by cash buyers each time. This experience has been quite frustrating, honestly. Although I had never done it in the past, I couldn't imagine it would be so hard to buy a home.

My agent suggested I look into other options, such as purchasing land and putting a manufactured home on it. The newer models are actually quite nice! I was surprised.

Now, I'm running the numbers for this project and it seems that I should still be able to stay within my original maximum budget of $400k. Although instead of buying an old house and fixing it up, I would have a brand new house instead. Pretty cool, right ?

But here's the catch: Since most lenders only do Conventional Loans for traditional home purchases, I've had to talk with a few lenders that only specialize in Construction Loans. I feel a bit dizzy trying to keep track of the numerous steps that go into structuring this complex type of loan.

From what I understand, first, they pre-approve me for an "umbrella" loan, up to a certain amount (let's say, $400k).They will then set the money aside for the duration of the project, and "draw" money from that reserve to pay for purchasing the land + improving the land (leveling, prepping city utilities...) + purchasing the prefab. Throughout this whole process, and before I can move into the house, I will be paying interests only on the amount being drawn, at a much higher rate of interest than current mortgage rates. After the project is complete and I can move into my house, they will refinance (or drop the interest rate) with a more traditional loan and I will then start paying at my actual fixed mortage rate and start paying down the principal.

Let's say, best case scenario, I purchase land for $150,000, land improvements are $50,000 and the prefab is $150,000. That's $350k and I'm within my budget. But throughout the duration of the Construction Loan, I will be paying high interests on $150k at first draw and on up to $350k, for a minimum of 8 months (2 months escrow + appraisal, 3 months land improvement + permits, 3 months home building) and up to 12 months if the project ends up taking longer.

After calculations, that is easily $10k in interests paid + $10k in closing costs (apparently, they are twice as high as regular closing costs) on the Construction Loan alone, so $20,000 total.

So, in essence, this means I am adding $20k of extra expenses on top of the project budget of $350k, and that's before I can get into my actual 30-year fixed mortgage once the house is ready to move-in, and I can start paying down my principal.

Am I correct ? Did I miss anything ? Is there a way to speed up / reduce the cost of this process that I do not know ?

Wow. I wasn't ready to go into such a complex purchase on my first home, but I guess it is what it is. Better start learning now.

Thank you so much for having read my post.

I wish you a great day/evening wherever you are!
Martin