Raising finances

Mike Hardwick sets out the basics of securing a project-friendly self build mortgage

Confused by self build mortgages? Build It’s project management expert Mike Hardwick breaks it down

There will be a few of you out there in the happy position of having cash available to build your own home. This might be from selling an existing property, or maybe inherited wealth. But, in my experience, most people require a helping hand to raise the necessary finances, and that usually means a mortgage of some sort. Historically, high street lenders have never quite understood the self build philosophy and, as it’s a much smaller market, nor have they been particularly interested. The good news is that the industry has developed over the last 20 years or so and it is now far easier to get the finance you need to contemplate a renovation or self/custom build project. So, how do you go about it?

Why do lenders hesitate?

Mortgage providers are typically pretty mercenary creatures. They lend you money with the idea of you giving it all back to them, plus interest, with as little risk as possible to their investment. They prefer the idea of lending against a tangible structure with inherent value, like an existing house, at around 80% of its market value, so if you default on payments, they can take the property back and sell it at a bargain price to get their money back quickly.

When a self builder asks for money up-front to buy a piece of land that they plan to put a new dwelling on, the lenders have an attack of the vapours – what if you don’t complete the project? What if it’s built badly and can’t be sold on? How can they get their money back? That’s why, in the bad old days, self builders had to either have a plot already, or the funds to buy land and construct at least the shell of a house before anyone would lend against it. It’s hardly surprising then that self build was the preserve of the wealthy. Arguably, most of the big lenders still have this attitude, but there are some enlightened souls who know different.

What is a self build mortgage?

Specialist brokers, such as Buildstore, recognised this gap in the market and, crucially, realised that self and custom builders don’t undertake this kind of project lightly. For many, it would be the biggest investment of their lives and by hook or by crook, they will finish it. Sadly, a few projects do fail due to unavoidable events such as illness, unemployment or even death. However, the vast majority are completed. If the small risk of failure was offset by an insurance policy to guarantee the project could be built out, the risk to lenders is negated.

It is essential for self builders to have money available to pay for their plot as soon as it is identified to avoid losing out. Once they have the land,

a further loan is required to fund the various stages of building, ideally in advance of the work.

The first step in the process is to speak to a qualified mortgage adviser with a specialist broker. The days of working out the size of mortgage you can have through multiples of income between you and your partner are gone. Now, it’s all about affordability – how much you can pay once all other financial commitments have been met and how resilient you are to any shocks to the market that might increase interest rates. Lending to salaried employees is straightforward because you can prove your income through payslips for the past year, but if you are self-employed, be prepared to show your detailed accounts for the last couple of years to prove your financial status.

Types of lending

Self build mortgages can be offered in ‘advance stage payment’ or ‘in arrears’ format. Arrears payments involve a valuation of work at each stage. The next bout of funds will only be released if this has been done to a satisfactory standard. This can create cash flow issues if you encounter any problem with the build or a downward adjustment in its valuation.

It’s usually preferable to opt for advance stage payments. Probably the best-known product using this method is the Accelerator mortgage, brokered through Buildstore. Using this product, an advance against land at around 75%-85% loan to value (LTV) will be agreed, followed by a second release of funds at a similar LTV to cover the subsequent build costs. This second tranche of money is broken down into discrete blocks to cover: preliminaries and foundations, timber frame erection or masonry up to wall plate level, to weathertight status, plastering and first fix services and finally, second fix to completion. While the mortgage is brokered by Buildstore, the funds are actually provided by one of the many smaller building societies that have signed up to the Accelerator scheme.

The principal benefit of advance stage payments is the positive cash flow it offers – you will be able to pay the invoices from your trades as and when they arise. By releasing the money in stages, the repayments build up incrementally, so you will only be paying the full monthly payments once the last stage of funds has been released. This offers the opportunity to stay in your current home for as long as possible while the build takes place. If you choose a Buildstore mortgage, you can have their project management experts undertake a cost check to verify that your figures are realistic and achievable. As these mortgages are cost-based, payments are guaranteed by the lender.

Interest rates

Will a self build mortgage cost more than a traditional mortgage? Yes, the rates are typically higher during the project, but this reflects the increased risk taken on by the lender. At the time of writing they are around 4.5%. The good news is that although the interest rates might be a tad higher to start with, the repayments are usually interest only at this stage and if you swap to a traditional repayment mortgage once the build is complete, the interest rates will come down.

Remember that the payments will remain similar or will perhaps even be slightly higher to reflect that the repayment element is now included, so don’t go by interest rate alone, look at the whole package. With interest rates at historically low levels, it’s possible to get some very competitive deals, but this will be down to your individual circumstances, so make sure you speak to an Fca-qualified mortgage adviser.

Other considerations

Remember that in most cases, a mortgage provider will expect to see a 10-year structural warranty in place for a new build, so it’s vital that you get one. Architects certificates may be acceptable for conversions and some projects, but always check first to make sure what is expected. You also need to seek specialist advice if you plan to buy an old property with the intention of knocking it down and replacing. It’s usually possible to get a traditional mortgage on this style of building, but they will not be happy if you decide to remove the structure they are lending against without their consent. If this is your intention, speak to a specialist provider so they can match you with a lender happy for you to take this course of action.