How to finance your build

2012-09-08 09:55

If you plan on undertaking a major renovation you

will need to approach your bank to extend your home loan. Strict rules

apply so it’s important to understand the implications, writes Maya

Fisher-French

If your home is worth more than your outstanding home loan, you will be able to draw down on this equity to fund your renovation.

However, if your existing home loan is close to the value of your property or you are building from scratch, you will need to apply for a further home loan or a building loan.

Banks view building loans as high risk because until the building is complete it is difficult to value the property.

Building costs are often higher than existing house prices and you would not necessarily be able to sell the property for the amount you spent building it.

Praven Subbramoney, the head of product and pricing at FNB Home Loans, says, for example, if you are building from scratch, until the municipality has approved the final building, the bank can only sell the property based on the land value if they have to foreclose.

The banks therefore apply a different set of rules to building loans. Before you start renovating or building a property, speak to your bank and ask them for a guide around the processes you will need:

Higher rates
In order to compensate for risk, banks charge a premium on their variable mortgage lending rate during the building process. Subbramoney says this also encourages people to speed up the completion as they then qualify for the lower variable lending rate.

Interest only
During the building you only pay interest on your loan and not the capital.

It is important to pay this interest otherwise it capitalises and increases your home loan.

Once the building is complete, the bank restructures the loan based on the normal lending rate over 20 years.

Documentation

The bank will require all your plans, agreements with the builder, full cost analysis as well as council and regulatory approval of your plans before releasing any funds.

Subbramoney says this assists customers as the bank is able to assess whether or not the quote provided is feasible and whether the loan will be sufficient to pay for the building.

This does mean a building loan will take longer to be approved as the department has to analyse all of the information.

Payment on completion

The bank will only release funds on completion of certain phases of the building.

Your builder will have to provide a plan, which breaks down your project into phases and how much each phase will cost.

Only once the building reaches a specified level will the bank release funds to pay the builder.

This means you need to find a builder that can self-fund portions of the project.

While this may be a frustration as many builders may not have the cash flow to do so, Subbramoney says one should be very careful about hiring a builder that cannot capitalise his own business.

“If you pay in advance how do you know your money is being used to buy the material for your property?

“The builder may use it to pay other creditors and run out of money for your build.”

Have a slush fund:

When building or renovating, make sure you have some extra money put aside and do not only rely on funding from the bank.

This money can be used to spend on extra finishes you want or to take advantage of special discounts for cash payments.


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