Should the Builder Finance Construction?
April 19, 1999, Revised October 10, 2002, December 26, 2006
I see three advantages in having the builder finance construction:
The builder who finances construction must include the financing cost in the price of the house quoted to the borrower before the construction period is known. The builder's inclination, therefore, is to assume a longer period (and therefore a higher financing cost) to cover the risk. On the other hand, the builder is eliminating the risk of an uncertain construction period for the borrower. Since the builder has some control over the construction period and the buyer has none, I think it is better for the builder to take this risk.
There are two possible disadvantages in having the builder finance construction:
"We are going to have a house built for us, and are wondering whether or not we should finance the construction or allow the builder to do it? Some builders won't do it but others will if the customer wants it… Is there any reason I should prefer to finance construction myself?"
I see three advantages in having the builder finance construction:
- You need to take out only the permanent mortgage, avoiding the complexities involved in having to decide between two separate mortgages and one combination mortgage. See Pitfalls in the Financing of Home Construction.
- You have assurance that the builder has sufficient financial capacity to do the job.
- A builder paying interest on a construction loan has an incentive to get the job done as quickly as possible.
The builder who finances construction must include the financing cost in the price of the house quoted to the borrower before the construction period is known. The builder's inclination, therefore, is to assume a longer period (and therefore a higher financing cost) to cover the risk. On the other hand, the builder is eliminating the risk of an uncertain construction period for the borrower. Since the builder has some control over the construction period and the buyer has none, I think it is better for the builder to take this risk.
There are two possible disadvantages in having the builder finance construction:
- The builder must have title to the land to obtain construction financing, and switching title is costly in some states.
- The buyer who is financing construction is committed to the transaction, making the builder willing to modify the design. The builder with less of a commitment from the buyer may be reluctant to make any modifications in the design that would negatively affect its marketability in the event that the deal falls through.
Shopping houses offered by different builders is a good idea in either case. Just remember that the price quote from a builder who finances construction is not comparable to the price quote where you must finance construction.