Should the Builder Finance Construction?

April 19, 1999, Revised October 10, 2002 "We are going to have a house built for us, and are wondering whether or not we should finance the construction or allow the builder to do it? Some builders won't do it but others will if the customer wants it� Is there any reason I should prefer to finance construction myself?" The advantage of having the builder finance construction is that you need to take out only one mortgage, and you have assurance that the builder has sufficient financial capacity to do the job. Further, a builder paying interest on a construction loan has an incentive to get the job done as quickly as possible. The only disadvantage I can think of is that when the builder finances construction, you don't know what you are paying for the financing because it is embedded in the price of the house. I don't view that as very important, however -- you don't know what you are paying for the kitchen either. Just remember that if you shop houses offered by different builders, the price quote from a builder who finances construction is not comparable to the price quote where you must finance construction. Postscript October 10, 2002 Scott Miller, a builder with experience in this area, has pointed out to me some other drawbacks in having the builder finance construction.  He points out that the builder has to borrow in the commercial loan market, and therefore may pay more for the funds than the borrower.  Furthermore, the builder must include the financing cost in the price of the house that is quoted to the borrower before the construction period is known.  The builder's inclination, therefore, is to assume a longer period (and therefore a higher financing cost) than is usually the case.  In addition, the builder must have title to the land to obtain construction financing, and switching title is costly in some states.  Finally, a builder who owns the property and is on the hook for the loan may be reluctant to make any modifications in the design that would negatively affect its marketability in the event that the deal falls through.   Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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