The Inner Workings of Interest Rates for Owner Builder Loans

A good owner builder construction loan will have only one closing to cover the land purchase, construction phase, and conversion to your permanent financing. Therefore, the owner builder loan will have two sets of interest rates: one while you build, and one rate for when you move into your new home. Every owner builder should understand the inner workings of these rates when planning to build.

The interest rate while you build your home is called the construction rate or the interim rate. For an owner builder construction loan, this rate should be locked in when your file is in underwriting. This means it should not change during construction.

The construction rate on owner builder loans is typically an interest only rate that should accrue only on the funds that you borrow as you build your home. There are some owner builder programs out there that will set the interest to accrue on the overall construction line of credit. However, you should try to avoid this if you can. It is better for you as an owner builder if the interest simply accrues only on the funds that you actually draw during construction.

But, what dictates the actual interest rate during construction on owner builder loans? Typically, this rate is tied to the Prime Rate, which is manipulated by the Federal Reserve. This does not mean that an owner builder should expect his construction rate to be set to the exact prime rate or even set to a simple calculation from the prime rate. However, it does mean that you should expect the construction rate to go up or down relative to the prime rate.

Many owner builders think this is the case for all types of mortgage rates, but they don't fully understand the difference. For example, a 30 year fixed mortgage rate will not adjust in motion with the Prime Rate the same way that a short term construction rate typically will. So, for an owner builder who wants a construction-to-permanent loan to build his house, it is important to realize the difference.

Now that you understand that the construction rate is fixed during the construction period and tied relatively closely to the Prime Rate, you should also understand that it's one of the least important features of an owner builder construction loan. Why would someone say such a thing? Aren't interest rates the most important part of a loan? Not if it is an interest only rate that only lasts for the short period that you're building your home.

In other words, if you only spend nine to twelve months building your house as an owner builder, and you are building a home that falls within the conforming loan limits, then differences in your construction rate are only going to have very minor effects on your overall project costs. This is especially true if the owner builder loan is set up so that the construction rate only accrues on the funds as you actually draw them during construction!

Now that we understand construction rates, what about the interest rate for when you're done building your home. When an owner builder finishes construction, he is ready to move into his new home, hopefully without having to go through another round of closing costs and fees.

At this time, the owner builder can lock in his permanent mortgage rate. A good owner builder construction loan will allow you to choose which type of loan program you want for your permanent financing. In other words, you can choose a 30 year fixed mortgage or some type of adjustable rate mortgage, etc. Of course, nowadays, almost every owner builder is smartly picking a 30 year fixed mortgage. But, it's nice to have the options available to you.

When you are finishing up construction, you will be able to lock in your 30 year fixed rate at that time. So, your permanent rate will float until you are done building. A good owner builder construction loan, though, will not mark up your permanent rate in any way. Therefore, when an owner builder should move into his new home at the lowest market rates available based on his credit qualifications.

A nice thing about owner builder construction is that you are building your home for much less than the actual market value of the finished home. Therefore, a good owner builder program will give you credit for the instant equity you have built into your property and will accordingly be able to finance your permanent loan at lower interest rates. For example, if an owner builder spends $240,000 to build a home that has an appraised value of $300,000, then the permanent loan should give him credit for $60,000 down payment.

In the example above, this permanent rate will be a nice, low interest rate, because the overall loan-to-value ratio is below 80%. And, as a bonus, you won't have any mortgage insurance to worry about paying either, which will save you even more money each month.

Overall, if you want to be an owner builder to build your own home, make sure you understand how the interest rates are structured for your loan. And, understand which features of the loan are truly important and worth worrying about. An owner builder who can do this will save himself a lot of trouble and money.