Like many first time home buyers, my wife and I were left frustrated over the past year or two searching for our first home. After years of renting while she was finishing law school, we were ready to make the leap and buy our first home so we could continue building our life together. Only, for one reason or another, we couldn’t seem to find the home we were looking for.
First, there seemed to be very limited inventory on the market. As Colin Zizzi wrote about in February’s blog, there are a multitude of factors causing the current housing shortage. From a low supply of new homes being built, to people locking in sub 3% mortgages during Covid, there just isn’t currently a large supply of existing homes coming on the market. This made the number of homes available for purchase within our desired price range, size and location very limited.
Because there was very little inventory, supply and demand imbalances continued to make it an ideal environment for sellers, and a not so ideal environment for buyers. Case in point, I recently had a friend tell me he lost out on a house before it even went on the market – the day before he was scheduled to see the property – because a buyer offered significantly above asking price with no contingencies, and without ever seeing the property.
There were certain things we just weren’t willing to waive, such as an inspection. We also didn’t want to pay a premium for a home that would also be requiring a substantial amount of improvements or ongoing maintenance.
Being left frustrated after visiting house after house and nothing came to fruition, we eventually met with a builder. Initially, building a home was never something we considered, but we wanted to have an open mind and explore other options. Now, as we move forward and wrap up the design process and move to construction, I’d like to share my thoughts so far to reflect on what the experience has been like and hopefully offer other home buyers insights into an alternative to the existing home market.
Once the home is complete and we settle and move in, I’ll write a second blog to review the overall experience and how the final product turned out versus our expectations.
What kind of home are we building?
Just a little background about the type of home we’re building since there are various ways one can go about building a new home. We went through a builder that is essentially a one-stop shop. They own the land that we purchase from them, they handle the structural and interior design, they hire and oversee the contractors for each phase of the build, and they offer mortgage and title services. There are pros and cons of using the new build method we chose, which I will outline later on.
Most of these builders also have model homes and newly built homes that are called “Move-in Ready.” While you do get many of the pros of a new home, you do not get the same level of customization and are at the whim of what the builder decided to install in that home.
The “Pros” of Building New
The first thing that really stands out is we felt like right now we were getting the most bang for our buck building new. We were getting the exact (or almost) home we wanted and we didn’t feel like we were paying a huge premium for a new home versus buying an existing one. The limited existing home inventory and competitive market landscape meant that existing homes are often selling for over asking. So what were the new build premium(s) I’m referring to that didn’t feel like they were hitting our piggy bank too hard?
Customization
- For starters, we can choose the lot, floor plan, structural design features, and interior design features exactly to the specifications we desired. When you buy an existing home, it is very rare to find a large number of homes within a geographic region that check all of the boxes. That is even rarer right now with the limited supply on the market. We had a one stop shop to build and customize our home which streamlined the process too.
Renovations
- That parlays into my next point: We won’t have to move-in and start construction on renovations for things we want to change or upgrade. For one, it wouldn’t be ideal for our personal situation to move into a home and then have ongoing construction taking place.
- Second, we know the price we’re paying is the price we’re paying. We don’t have to budget for extensive renovations on top of down payment and closing costs, which can be more difficult to budget for in this competitive market which can require more cash to close, as well as harder to predict renovation costs.
Maintenance
- Maintenance: As Colin Zizzi talked about in last month’s blog, we typically recommend clients budget 1-2% of the home’s value annually for ancillary expenses and maintenance. With a new build, the figure is on the much lower end of that spectrum. With an older home that may need extensive upgrades to essential structural and mechanical components e.g. roof, HVAC, chimney, windows, this can be more than 2% a year and become a hefty budget expense.
For these reasons, we thought the minimal new build “premium” created by an ultra competitive existing home market was well worth the extra cost. There is also a non-financial aspect to a newly built home – just like buying a new car with a warranty – there is the peace-of-mind premium that comes with something being newer and less likely to have problems.
The “Cons” of building new
Negotiating Power
- The overall housing market right now gives very little power to buyers, whether purchasing a new or existing home. Builders know the existing home market is very tight and they learned their lesson from the great financial crisis in 2008 and have not created a supply glut; this has given builders most of the negotiating power right now. When it comes to negotiating price and builder concessions, buyers have very little room to work the terms in their favor.
Cost of Time
- When purchasing an existing home, there is usually a period of time between when the home goes under contract and when the buyer settles and moves in. This can be anywhere from a few weeks to a couple months depending on the type of sale (cash or mortgage) and when the seller wants to move out.
- If everything stays on track with the current builder estimated timeline, from the time we first met with the builder until the time we settle and move in, the total time will be approximately 8 months. It isn’t ideal or even feasible for many people to wait this long; personal situations may not make it possible for many people that have growing families or work relocations to wait ⅔ of a year, or more, to move into their new home.
- Personal time spent: We had 6 meetings with the builder to review everything from expectations, timeline, structural design, interior design, and a final review and commitment meeting. Our one design meeting took 5 hours. There are more meetings to come throughout the building process. In addition, there are also extra loan meetings with the bank providing the construction loan. That doesn’t account for the time my wife and I spent outside of those meetings reviewing design and the thousands of options we had available. Be ready to commit a lot of your time during the initial few months to design your home and meet with the builder multiple times.
Construction Costs
- This is the biggest “con” in my book. Many builders, ours included, pass on the construction costs to the buyer. I’m not referring to the actual home purchase, but the cost of funding each step of the construction process before you get to settlement and move in. With a conventional loan, the mortgage payments typically start the month after you settle and move in. With a new build, there is usually a construction loan that starts when construction commences, not when you move in.
- With a construction loan, ours specifically, we put a minimum of 5% down for just the construction loan and the lender supplies the cash to the builder. Each step of the way, we must pay interest on the various costs associated with building the home. When the lot is purchased, digging starts, the foundation poured, the framing started, we have to pay interest on the cost to do each of those things. In total there are 5 “draws” with our builder; as each draw occurs the total accrued construction cost grows, and our interest expense increases. Once we settle, the construction loan ceases and converts to a mortgage, and the 5% down for the construction loan is rolled over into our down payment.
- Because there are essentially two separate loans, there are origination and recording fees for two separate loans. What we’re seeing many lenders do, for both new and existing home mortgages, is tack on extra fees to make up for the lack of mortgage volume created by limited home sales in this current market.
- Cost overruns. We were informed by our builder that there can be cost overruns associated with the building process that are passed on to us. For instance, encountering rock when digging that may require extra equipment and man hours to break up and remove.
Multiple Housing Payments
- While it is only for a short period, the construction loan costs can get hefty. Like many short term loans they have an origination fee and also a higher interest rate, which is only exacerbated by the current interest rate environment.
- Most people building a home have either a current mortgage or rent payment, depending on their situation. It may not be financially feasible for some people to essentially pay two housing payments for a period of approximately 6 months.
- In our case, we’re able to stay with family for a few months between when our lease ends and our house is ready to move in. We are extremely grateful and realize not everyone has this luxury.
Customization
- We didn’t get complete freedom to customize our home like you would think. We had set floor plans to choose from. And not all floor plans were available in the community we decided on.
- To keep things streamlined, builders don’t give complete structural and interior design freedom either. There are limited structural designs such as outside appearance, siding and stone options, porches, etc to choose from. And there are a set number of interior design options such as cabinets, countertops, tiles, etc to choose from.
- If you want to upgrade to nicer features, the builders will charge you, and often charge you a lot. Nickels and dimes – or when building a house, dollars and thousands of dollars – can add up quickly.
- If you want something that is not included or you find the pricing too expensive on certain customizations, you’ll have to contract with someone after your home is completed. Do you really want to move into a newly built home and start renovations? This negates one of the main pros of building a new home: It’s move-in ready.
A few things that were pros and cons
There were some dynamics that turned out to be both pros and cons for one reason or another.
Incentives & Preferred Partners
Many builders offer incentives. I’ve seen cash, finished basements, appliances, blinds and more, offered as incentives. Getting “free” stuff is always nice, but as with most things in life, getting something for free doesn’t mean it’s completely free.
- Builders have preferred lenders and title companies. They can force you to use their preferred lender and/or title company to receive the incentive(s). The lenders and title companies will often tack on extra fees to compensate for the money they had to pay the builder to become the preferred company and have business funneled their way.
- Usually those extra fees cut into your incentive, as was our case. Instead of a $10,000 incentive, the extra ancillary fees from the lender and title company cut the incentive about in half.
- This is a catch-22 because usually it still makes sense to go with the preferred providers. The incentives are too sweet to pass up, even if they aren’t equal to what was advertised when you take into account the associated extra fees. We still went and requested quotes from outside lenders just to make sure the best deal, when all said and done, was with the preferred lender.
Construction Loans
While footing the bill for the construction loan wasn’t the most fun for our wallets, it actually did have a few benefits financially.
- We were able to continue saving and accumulating cash so when we do settle and move in we will have additional funds for furnishing our home.
- We also don’t have to lock in our rate right now. We lock it in closer to when we settle and move in. With the current interest rate environment this gives us time so see if inflation cools and rates drop before we lock in our fixed loan. Obviously, this could go the opposite way and rates could increase by the time September rolls around!
Closing thoughts
As with any home purchase, the most important thing is that it fits your specific situation. I mean this from both a financial standpoint – that it is feasible from both a cash outlay and budget standpoint – but also from a non-financial perspective as well. The home decision, whether to rent, buy an existing home, or build a new home, should fit with your goals and take into consideration your time horizon, family dynamics, and job situation.
The overall experience has been great so far and we are happy we went this route, but that doesn’t mean the process was without its annoyance. It requires patience and a commitment to time. There can also be extra cost associated with the construction process. But, with today’s tight existing home market, I would implore more buyers to at least consider a newly built home.
Once we have moved in and have had time to reflect, I will write a second part to this blog examining how the final product turned out versus our expectations. Stay tuned for Part 2!
