Opting to have a home built rather than purchasing an existing one can provide various benefits, such as the potential for lower maintenance costs and better energy efficiency. However, many people wonder how the lending process for new construction homes works since there is no historic market value of the property to refer to during the appraisal process. Read on to learn how property appraisal works with a newly built property to determine what lenders examine.
Value vs Cost vs Price
Before getting into how real estate valuation works on new homes, it’s essential to understand the difference between the cost of a home, its price, and its market value. The cost of a property is how much money was needed to build the home, while its purchase price is the amount the buyer pays for it.
When you’re custom building a home, the price and the cost will be similar or pretty close to the same, but this is the case much less often when purchasing an existing home from its previous owner. Home prices fluctuate based on economic conditions, so the price of an older home may very well be significantly higher than the original cost to build.
The market value of a home is an estimate of how much a property is worth at a particular point in time. An appraiser determines the market value by performing a real estate valuation. Lenders base their decisions on the market value of a home rather than on the cost or purchase price, but these figures help inform the appraiser’s estimate of the value.
How to Determine Property Value: The Basics
Four main factors that contribute to an estimated property value:
- Demand: How many people are looking for homes in an area that are similar to the one being appraised?
- Utility: How well can the property meet the needs of future owners?
- Scarcity: How many competing properties are on the market?
- Transferability: How easily can the ownership rights be transferred to another party
Appraisal of New Construction: What You Need to Know
To begin having a new home built, you need access to funds to pay the building contractor, but you also need an existing property to be able to get a mortgage. As a result, lenders typically grant a home construction loan that can later be converted to a mortgage loan. The appraisal process helps lenders determine whether the home’s value when completed will be enough to cover the loan amount so that the financial institution can use the property as collateral for a mortgage.
What’s Used for a New Construction Appraisal?
To arrive at a valuation, an appraiser needs to obtain some key documents from you, including:
- Plans: Drawings that show the floor plan of the home and provide the square footage for each space and the overall size of the home
- Specifications: List of all the materials that will go into the new home, including construction materials, flooring, countertops, appliances, and everything else that will be in place before you move in
- Cost breakdown: Document that shows the costs of land, building materials, and labor
- Plot plan: Diagram that shows where the home will be positioned on the lot and also maps out the locations of accessory buildings, septic and well systems, drainage directions, and finish-grade elevations
Typically, you can obtain all of these documents from your home builder. Then, you turn them over to the lender, who provides them to the appraiser.
How the Appraisal Process Works
Once the drawings are received, the appraiser will use the information to determine a value using the cost approach and compare the home to other homes on the market to arrive at a market value. The lender will then grant a home construction loan based on this estimated value.
Once construction is complete, the appraiser will return and assess the property again to arrive at a final estimated market value that the lender will consider when converting the loan to a mortgage. Changes made during construction may make the final market value higher or lower than the initial estimate.