Everything you need to know about self-constructed mortgages
each of us loves the idea of building our own house, designing it as we wish and personalizing it according to our tastes.
Yet even if you are a prime contractor, it will still take some investment, which is where a self-constructed mortgage comes in.
Our guide explains the different types of self-constructed mortgages available and how you can go about them.
What is a self-constructed mortgage?
A self-constructed mortgage is a loan you take out that provides financing so that you can build your own property.
Loans are different from a standard mortgage because there is no collateral (i.e. existing property) that the bank can lend against.
This means that instead of receiving a lump sum, you receive the money in stages. This reduces the risk for the lender, who can verify that construction is progressing as planned and that you are spending the money for what it is intended for.
When are funds released for a self-constructed mortgage?
Funds are released in installments, usually when you reach the following stages of construction:
- When you buy the land (and get a building permit)
- The foundations are laid
- The property is built up to its eaves
- The roof is finished (windproof and waterproof)
- First solution (i.e. plastering)
- Second solution (i.e. final electrical and plumbing)
- Certified as completed by a surveyor
What types of self-constructed mortgages are available?
These types of specialized auto-construction loans fall into two categories:
Arrears: The funds are released after each of the agreed stages of construction has been completed. This is the most common type of mortgage loan, the challenge is that you need to have enough cash to get started.
Advanced: The funds are released before every stage of construction. This has obvious advantages for those who have less money up front because you have the money to pay for materials and labor.
But because the risk to the lender is greater – because construction may not go according to plan or budget – fewer lenders are willing to offer this type of self-constructed mortgage.
How to get a self-constructed mortgage?
Self-constructed mortgages are traditionally rarer than standard mortgages with less availability from Main Street banks. You may need to turn to a specialist lender and a mortgage broker or advisor should be able to help.
Earlier this spring, the UK government launched its’Help to build‘, a £ 150million initiative designed to make it easier and cheaper for people to build their own homes.
What loan criteria must be met?
Since most self-constructed mortgages are mortgage loans with arrears, you’ll usually need a large deposit to get started. This is typically at least 25% of the total cost of the land and estimated construction.
You will also be responsible for the costs of an initial appraisal and an “anticipated value”. A building permit is required, as is approval of the plans for the property you wish to build.
Some lenders may restrict the type of construction they lend on to common structures such as masonry and traditional timber framing. Whichever structure you choose, it will have to go through building rules.
You will also need to show a projection and a cost breakdown to convince the lender that the plan is feasible. Some will insist that a qualified quantity surveyor provide this information, and you will need to plan for a contingency in case of budget overruns – usually around 20%.
Affordability is also a consideration. If you are renting while the property is being built, a lender will factor in these costs.
How do interest rates compare?
Due to the additional risk for lenders, interest rates on self-constructed mortgages are normally higher than on standard mortgages.
The rate varies but can be around 4% to 6% in mid-2021. Arrangement fees will also vary depending on the terms of the broker or lender and you could be tied for one to three years.
Once the property is confirmed as habitable by a land surveyor, you may be able to downgrade to a lower interest rate during the tie-in period without penalty.
Although fewer lenders are offering self-constructed mortgages, you will still have access to different types of mortgages, including fixed rate and follow-up options.
Are there additional papers?
Compared to other forms of mortgage loan, you will need to produce additional documents when applying for a mortgage loan.
This generally includes the production of documents relating to:
- Building permit
- Construction plans
- Project cost estimate
- Approval of building regulations including SAP calculation (energy consumption)
- Construction site insurance and structural guarantee
- The professional civil liability guarantee of the architect
What are the advantages and disadvantages of a self-constructed mortgage?
- Interest rates are higher, which makes borrowing more expensive
- Limited choice of lenders
- Strict loan criteria, including a large deposit
- Risk of construction budget / deadline overrun
- You will be funded to build your own dream property in the style you choose
What is the alternative to a self-constructed mortgage loan?
If you already own a property with enough equity, you may want to consider a bridging loan.
This is where you remortgage to pay for the land and the costs of building your new business and when done, sell your old home to pay off the loan.
The downside to bridging loans is that they can be more expensive. This is a short term option where the arrangement fee, and even the exit fee, can be quite high.