The Rising Costs of Lumber and Materials is Coming at a Cost of Many Dreams
I help people every day with their construction loans. We do a LOT of them. I have said many times that they are my absolute favorite loans to do because I get to be a part of one of the most exciting times in a person’s life - the building of their dream home. A sanctuary that they have been envisioning for years. The time it takes for plans to come to fruition can be traced back to childhood sometimes. Excitement mounts exponentially as the dream finally gets put onto paper. It is a big deal.
Until the lumber and material prices jump like 300% in a short period of time. It is starting to threaten many dreams of building a custom home of their own. Even worse, I am seeing people that just closed on their construction loans unable to start building because the costs are so rapidly increasing. Day after day, I am getting phone calls, “Jen, we just can’t do it. We need to cancel the loan.”
What can you do to avoid these pitfalls of these soaring prices?
First, I want to put into perspective some costs and how current interest rates are making a difference currently.
I believe that what is keeping the current market strong even now with new construction is 2 things:
- There is a shortage of existing home inventory.
- Interest rates are low. They are definitely softening the blow of the rising prices.
For example, here is what a $600,000 loan look like at 3.5% interest:
- P&I is $2694.27/month
- Total payout over 30 years $969,937
On the flip side, a $500,000 loan at a higher 4.5% rate looks like this:
- P&I is $2533.43/month
- Total payout over 30 years $912,034.80
The difference equates to approximately $58,000. THAT’s how much interest rate plays in these factors. The low rates now are definitely help to mitigate the rising costs. This should make some of the people who are building now feel a little bit better.
I believe that if we see as little as a 1% increase in interest rates, things will most definitely change. A lot of people will forgo their dreams a little longer, with hopes of a price decrease and normalization. Or maybe they will just build much smaller houses.
With that said, here are some things that you can do to help your process along if you are planning on building a home in the very near future.
- Have realistic expectations. I have found that most people don’t. The days of building a home for $120/sq foot are gone. To be safe, I would budget at least $185-$200/sq feet minimum for your home cost.
- Build in a large “contingency” line item into your overall budget. A contingency percentage is kind of like “just in case” money...just in case you run over budget on something. I would recommend at least a 10% of your overall construction cost contingency built in, even if you are working with a builder who does a fixed price contract. If you don’t use the money, then it will go as a principal reduction on your permanent loan. If you DO need it, you will have access to it. Otherwise, you will be paying cash out of your pocket for the cost difference. This can get pretty expensive if you are not prepared.
- Make sure you are working with the right builder. If the cost seems too good to be true, it probably is. Foolish expectations or just plain not knowing don’t mix well with the reality of building a custom home. Check references. Talk to their current and past clients. Do your homework.
- Have extra money saved ahead of time. I will tell you that there has hardly been one person who hasn’t changed something during the building process. It is just reality.
- Consider building a smaller version of your dream home if the costs are far beyond what you can afford.
What happens if you are already closed on your construction loan and know you will run out of money?
Go back to the bank that did your loan and see what your options are. Typically, there will be 5 different scenarios that you will be presented with.
- The bank can go and reassess your existing loan to see if an increase can be tolerated guideline-wise. Obviously, not only will you need to prequalify, but the lender will also need to make sure that you aren’t currently maxed out on your loan to value etc.
- The original lender may also choose to do a second lien for the extra money. Again, if you are already at your max LTV, your lender might order another appraisal to determine whether or not the increase I cost can be covered with the rising home values. Both of these options mentioned so far do take some time and any expenses incurred will be on your dime. It is not guaranteed to work though.
- Pay the additional costs out of your pocket. If you don’t have the cash available, you might inquire about taking money from investments or retirement to cover the difference in cost. (Side note, this is where having a reserve contingency would have sure come in handy).
- Go back and pick less expensive finishes to go into your home. Maybe instead of the wood floors, you pick vinyl flooring (trust me...they have come a LONG way...they are gorgeous now!). There are many things that you can “downgrade” that are just as nice as something that costs 5x as much. You may have to compromise a little more during construction and then replace things after you are living there if you do find yourself actually wanting to. You never know.
- Finally, you could just decide that the price increases are just too much for your budget and it knocks you out of the market so you can no longer build. This really needs to be decided before any building starts. Otherwise, it will be a nightmare. The money used for the construction loan would have to be paid off and you would have to make sure that anyone who did work on the property has been paid. There won’t be any refunds for costs you already incurred. This may result in either you selling your land or refinancing the construction loan into a regular land loan. You could also pay cash to pay off the existing construction loan balance on the land.
To summarize, you just need to be smart about the process. Have realistic expectations. Plan ahead for price changes. When you know what you are getting into ahead of time, the process will go a lot smoother.
Avoid the pitfalls than many have fallen into and learn from their mistakes.
Will the price ever go down? I don’t know. I know that they will stabilize when the demand is down, but I am not seeing that anytime soon.
I still think that this is a great time to build, as long as you are prepared.
Thank you so much for reading today. I hope that I made you smile and think a little bit. Be sure to check out my Podcast on iTunes, Soundcloud and Stitcher ---- Jen’s 10 G’s